Home equity is a powerful tool to have if you're looking to put some cash in your pocket. With it, borrowers can take advantage of home equity loans and lines of credit. But when you're using your home as collateral, you must use it wisely.
To get more information about how borrowers should approach a home equity loan, we spoke with Amplify Credit Union's Real Estate Loan Agent Supervisor, Alex Rodriguez. He gave some insight into why home equity loans are beneficial and a few helpful tips on the best and worst uses for your money.
Why Use Your Home Equity
"There are a few key differences between home equity loans and other loan options, such as personal loans or credit cards," Rodriguez explains. "These are collateral requirements, interest rate, repayment periods, and maximum loan amounts."
Using your home as collateral means less risk for a lender, especially when you are applying for a large loan amount.”—Alex Rodriguez
For starters, interest rates are lower when using home equity, and the repayment periods are longer. "Generally, a personal loan rate can range between 7% and 36%, compared to a home equity loan of 3% to 7.5%," Rodriguez adds. "Home equity periods also range between 5 and 20 years, which means a more comfortable repayment period." For comparison, personal loans often feature a repayment period of between one-to-seven years, making home equity loans a more long-term investment.
On top of this, you can also borrow more than you can with a personal loan. When you apply for a personal loan or credit card, the lender will only give you an amount that you have a history of managing. If you've never taken out a high-dollar amount before, it can be a real challenge to get approved.
Why the differences? "Using your home as collateral means less risk for a lender, especially when you are applying for a large loan amount," Rodriguez says.
And there's generally no length of ownership requirement— what you can borrow depends on the amount of equity you have. "As a rule of thumb, lenders will generally allow you to borrow up to 75-80 percent of your available equity, depending on the lender and your credit and income," Rodriguez explains.
Your home equity options
When using your home equity, you have two main options: a traditional home equity loan or a home equity line of credit (or HELOC). The two are similar in their benefits but differ in how the funds are disbursed.
With traditional home equity loans, you receive the money you borrow in one lump sum once you close. On the other hand, a HELOC gives you the ability to draw money multiple times from an available maximum amount.
Best Uses for Home Equity
When it comes to using your home equity, the sky's the limit. "There are no restrictions on how and what to use your home equity loan," Rodriguez notes. However, some uses are more beneficial than others. If you're looking to make smart money moves, consider the following methods.
Some people choose to pay off expensive debt from personal loans and credit cards with a home equity loan with low-interest rates and a comfortable repayment period. It'll help you save in interest costs and relieve the pressure of bills stacking every month. Just be sure that you halt any poor spending habits before you consolidate your debt. If you continue to make bad financial decisions, using your home equity may drag you further into debt.
Remodeling a bathroom or kitchen, updating landscaping, replacing HVAC systems, building a pool, and installing eco-friendly home features are just a few projects that might tap into your home equity. But some home improvement projects may actually allow you to build equity over time as well.
Since some renovations have a high return-on-interest, you may ultimately increase the equity in your home. The best projects are those that increase the home's value beyond the money you spent on upgrades. When it comes time to sell, this will enable you to turn a profit.
Very few people can afford to make tuition payments without some form of financial assistance. For some homeowners, a home equity loan is a smart way to stretch payments out over time. More and more people are tapping into their home equity to fund college tuition for themselves or their children. You can often find better loan terms with a home equity loan than you can with unsecured student loans, making them a lucrative option.
One bad day can lead to thousands or even tens of thousands of dollars in expenses. Having an existing home equity loan or HELOC can give you peace of mind that bills will be covered. This is especially true if you have a medical emergency or need a significant home or car repair.
Here Rodriguez adds one critical caveat. "The typical processing time for a home equity loan is 20-30 days from application to closing. So if there's urgency, I would recommend a personal loan, which typically closes within 48 hours."
However, even if you use a personal loan, you can turn around and pay it off with a home equity loan. "You can always work on your home equity loan application in the meantime," he explains. "Once finalized, you can consolidate the personal loan into your home equity and save on interest."
Worst Uses for Home Equity
Remember, when it comes to borrowing money, the "why" is often much more important than the "how." Here are a few potential purchases that, according to Rodriguez, are not a great fit for a home equity loan.
"Most of our members use [home equity loans] for upcoming larger expenses over $20,000," Rodriguez says. If you're looking to pay for smaller expenses - such as a one-time gift or consumer electronics - you should search for options other than a loan or line of credit. In these situations, a traditional credit card or secured credit card is better if you can pay off your monthly balance.
High-end vehicles and boats
We know— it's tempting. People regularly try to use their home equity loan to pay off big-ticket items like cars, boats, and RVs. But because of the extended repayment period, you may be paying more for your investment thanks to accumulated interest. You can usually find a comparable rate on an auto loan.
Investing in the stock market
With your house on the line, it's not wise to gamble with your home equity. While it is certainly possible that you make money investing with the funds, there's also a chance that the stocks don't shake out the way you planned. If you lose your money, you still have to come up with a way to make your monthly payments or risk losing your house.
Having home equity in your house can come in handy in numerous situations. Like nearly everything in the financial world, however, it's a power that can be used to your advantage or abused. Choose your uses wisely and always take to your financial advisor before making a decision.