What are the best uses of a second mortgage or HELOC?
Tips to using home equity wisely
- Home improvements, debt consolidation and emergency expenses are good reasons to tap equity.
- Disposable purchases and vehicle purchases are poor reasons to tap equity.
- Interest rates should help determine which type of loan you choose.
- Equity loans carry a risk of foreclosure; other loan types do not.
One rewarding aspect of home ownership is building equity. You build equity by making payments or home improvements, or as surrounding property values rise.
It’s tempting to start using that equity to buy something practical or extravagant. Maybe you need to replace an unreliable car, help your child pay for college or just want to go on an extended vacation to a tropical land. Tapping into home equity may or may not be the wisest choice.
Think about your goals and speak to your lender to help determine whether a second mortgage – also known as a home equity loan – or a home equity line of credit (HELOC) is best. You may find you’d do well to search for other options.
When should you tap equity?
Here are three of the better reasons to get a second mortgage, also known as a home equity loan or a home equity line of credit (HELOC).
If you’re looking to increase the value of your home but don’t have enough ready cash, a home equity loan or HELOC can help accomplish your goal. Before doing so, make sure you’re likely to recoup an equal or greater value than what you’re investing. For instance, according to a 2016 article in Remodeling magazine, projects with good cost-to-value ratios were fiberglass attic insulation and manufactured stone veneer, as well as replacement doors for the garage and entryways. Projects with the worst cost-to-value ratios were bathroom additions, master-suite upgrades and composite deck additions. What about kitchens? Depends on what you’re doing. With any improvement project, the general rule is the simpler and less expensive the project, the more value you recoup. Do some research or check with your lender or a local Realtor to ask about local trends.
As of March 2016, the U.S. Federal Reserve said, the average credit card debt for an American household was $5,700, and the average balance carried was more than $16,000. With two or three credit cards per person, interest charges can often be overwhelming, making balance transfers to a single source attractive. Using a home equity loan or HELOC to consolidate is a good strategy since the interest on such loans is usually lower. Consider cutting up your credit cards and changing your spending habits to avoid racking up more debt.
Medical bills, unemployment or essential household repairs can be a fact of life, and they’re things that can’t always be anticipated. Compared to making a withdrawal from a retirement fund or using a credit card, drawing upon equity is a good move. Equity-loan interest is usually much lower.
When should you keep equity?
Here are three of the better reasons to leave your equity in place and research other options to meet your goals.
Disposable purchases or monthly bills
Purchases that don’t include a return on investment are generally a poor use of home equity funds. They include items like luxury cars, recreational vehicles, boats, vacations, televisions, computers and furniture. Similarly, paying your utility bills, cell phone bills or property taxes with equity won’t increase your net worth. Trimming your household budget to fit your income is advisable.
Purchasing a vehicle
Even if you’re looking to buy something practical that’ll get you from point A to point B, the costs of a second mortgage or HELOC are often higher than what you’ll pay for an auto loan or personal loan. Plus, borrowing equity carries the risk of foreclosure, so if you can’t make the loan payments, you could lose your home. If you default on an auto loan, you only lose your car.
There are arguments to be made on both sides. If you access equity, you then have a chunk of cash that can grow larger if you make smart choices. Maybe you’re looking to purchase stocks, buy a second home or invest in a property for rental purposes. If you’re an experienced investor, you likely have a safety net because you know how to cover your costs. For example, if you’ve purchased a home that you’re renting to others, your rental income may need to cover a mortgage and taxes for that home, any associated maintenance costs and your own equity-loan payments. But if you’re new to investing, there are many fluctuations within the stock and real estate markets that could push risks too high.