One of the many reasons owning a home is considered the “American dream” is because a house builds up equity over time (to estimate a home’s equity, subtract the remaining mortgage balance form the home’s market value). Home owners can then borrow against that equity to pay off debt or finance other big dreams. But it can be confusing to use home equity responsibly.
While this is certainly one of the benefits of home ownership, there are potential drawbacks, too. It’s important to remember that by taking out a home equity loan, there’s a risk you could lose the roof over your head. That’s why you want to think long and hard before doing it. Here are 3 ways to use home equity responsibly and 2 ways you should avoid.
Responsible Ways to Use Home Equity
Make Home Improvements
One of the best and most common reasons to take out a home equity loan or line of credit is to make improvements to the home. Keep in mind though, the improvements should be essential long-term fixes, such as putting on a new roof or restoring old plumbing. Try to avoid using home equity for short-term cosmetic upgrades you may get tired of quickly.
Pay Off Credit Card Debt or Other Debts
Because a home equity loan typically has a fixed interest rate that’s lower than many credit cards, it may be an option to help you consolidate and pay off other debts. Before taking this route, however, consider your spending habits. Using home equity to pay off debt is only a smart choice if you are disciplined enough to not run up the debt again. If you have no plans to curtail your spending, it’s not a wise move to use home equity to pay it off. Additionally, you risk losing your home if you can’t pay it off.
If you need help with problem credit card debt, consider our free credit counseling, which provides a personalized budget and action plan to help you get back on track.
Paying for a College Education
With no end in sight for the student loan crisis, many families are looking at other ways to pay for their children’s college education. In some cases, paying for education costs can be a wise use of home equity. Here again, it’s important to have a plan in place that includes additional educational funding options, such as scholarships and work-study programs.
If you’re considering using home equity to pay off current student loan debt, you’ll want to investigate all your repayment options first. Contact your loan servicer or visit studentaid.gov to learn more about the types of repayment plans currently available.
Ways You Should Avoid Using Home Equity
Travel and Vacation
Many people have a dream vacation on their bucket list. But using a home equity loan to pay for it is not the way to make it come true. Regardless of how incredible the trip is, it’s only temporary. A better choice it to plan and save up money over time to take the trip. You’ll have an even better time knowing you will come home with lifelong memories, and no additional debt.
Toys, Vehicles and Other Gadgets
When you realize how much equity you have built up in your home, it’s tempting to splurge on big-ticket purchases. But that equity isn’t free money. You should only use it for things that will have long-term, meaningful effects on your family’s financial future. You don’t want to get in the habit of viewing your home’s equity as a bottomless ATM.
