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How to Use Your Home Equity to Get Ahead Financially

Most homeowners probably know home equity is a good thing, and that's about it. It's why so many people leave this financial resource untouched. Here are some creative ways you can get the most out of your home equity.

What Is Home Equity?

HOME EQUITY LOAN

Home equity is the amount of the home that you own. One way to tap into it is through a home equity loan. You receive a lump sum of money that you back over time. You are borrowing against the equity you already have in the house. Lenders typically require borrowers to maintain at least 15 percent of the home's equity.

HOME EQUITY LINE OF CREDIT (HELOC)

Like a home equity loan, a HELOC involves borrowing against the equity you've built up in your home. Instead of a lump sum, though, there are two pay periods. The draw period lets you use the HELOC like a credit card to fund expenses. During the repayment period, you pay back the principal with interest. You also can no longer withdraw money from your equity.

CASH-OUT REFINANCE

A cash-out refinance involves borrowing more money than what you owe. As a result, you receive the difference in funds and replace your existing mortgage. Lenders typically limit the cash-out to 80 to 90 percent of your home’s equity.

Take on Home Improvement Projects

Home improvement projects are among the best investments you can make. Even something as simple as replacing your garage door comes with a 97.5 percent return on investment (ROI). It is why most homeowners use their home equity to upgrade their property.

Tapping into your home equity is especially useful if you plan on selling your house soon. The key is to focus on adding value, such as energy-efficiency or safety. Adding features for the sake of adding features will not give you the optimal ROI. Note that you can deduct the interest paid on home improvements up to $750,000.

Start a New Business

An equity loan has some advantages over a traditional business loan. For instance, they offer lower interest rates, and the interest is tax-deductible. Once you show a sound business plan to your lender, the loan will provide a quick source of capital for the new company.

Note that some lenders will only approve a loan if the business is not the primary source of income. That is because 50 percent of companies fail within five years. If that happens, you still need a plan to repay the loan.

Buy a Second Home or Rental Property

As a rule of thumb, real estate and rent prices increase over time. The more property you own, the more you can ride the value appreciation. People that take out an equity loan for this purpose tend to have higher property values and requested loan amounts.

According to Auction.com, house flipping has an average ROI of ten percent. While there is a lot of sweat equity involved, flipping a $300,000 would net you a cool $30,000. If you opt to use the second property as a rental, the monthly rent can help pay back the home equity loan or HELOC.

Pay for College Tuition

There is a strong correlation between education level and career earnings. A HELOC or home equity loan can be a savvy way to pay for a college education because the interest rate is often lower than that of student loans. In fact, home equity loan rates have dropped recently, making the gap between student loan rates and home equity rates even wider.

A HELOC or home equity loan is slightly riskier than a student loan. That’s because your house is collateral. If you fail to repay the loan, you risk foreclosure. As long as you can reliably make payments, though, you’ll be just fine.

Invest in Your Future

Ask yourself one question: “Will the value of my investment exceed the cost of my loans?” If the answer is yes, then you should use your home equity to invest in a different asset. This logic applies whether you are investing in the stock market, bonds, gold, or something else entirely. Selectively considering your investments and costs can pay off handsomely in the long run.

Settle Your Debts

You can use your home equity to consolidate your high-interest debts into one low monthly payment. That includes auto loans, credit cards, or medical bills that insurance didn’t cover. When used correctly, you can eliminate your debts, improve your credit score, and gain financial leverage for the future.

This strategy can backfire if you pay off your debts and then run them up again. You’ll ding your credit score and flirt with foreclosure. Stay on top of your repayments, though, and you should have no problem.

The Bottom Line

The only limits to using your home equity are in the imagination. When deployed properly, it is a useful tool to eliminate debts, fund ambitious projects, and strengthen your credit score. You should only take out a loan, though, if you are confident you can pay it on top of your existing mortgage.

Already know what to do with your home equity? Talk with one of our mortgage advisors to get started today.