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MoneyWatch: Managing Your Money
By Tim Maxwell
Edited By Matt Richardson
/ CBS News
While the economy has made everyday expenses more costly for Americans over the past few years, it's had a positive impact on home values. According to real estate research firm CoreLogic, the average American homeowner had more than $274,000 in equity in early 2023. That figure represents a $182,000 boost since before the pandemic.
Many homeowners sitting on such significant sums of home equity are tapping into that equity for cash for various purposes, ranging from consolidating high-interest debt to funding home renovations. However, every loan and credit product comes with a certain level of risk, and home equity loans and home equity lines of credit (HELOCs) are no exceptions.
Not sure whether you should take home equity out of your home? We asked some experts about when using your home equity may or may not be worth it. If you're considering using home equity then start by checking the rates you would qualify for here.
When borrowing from your home equity is a good idea
Using your home equity may be a good option when you use it to improve your financial position, such as in the following scenarios:
Making major home improvements
Projects like remodeling your kitchen or adding a new room can increase your home's overall value. According to the IRS, you may even qualify to deduct the interest charges if you use the funds to buy, build or substantially improve your home.
Sarah Alvarez, vice president of mortgage banking at William Raveis Mortgage, recommends HELOCs over another loan option. "Rather than doing a cash-out refinance in a high-rate market and potentially losing a 2%, 3% or 4% rate on your first mortgage, you can take a HELOC as subordinate financing to tap the extra value of your home."
Explore your HELOC options here now.
Paying for higher education
"Some student loans, especially loans for medical or law school, can have very high interest rates," says Doug Carey, CFA and founder of WealthTrace. "If you have significant home equity, using it to finance education expenses for yourself or a family member might be a cost-effective option compared to high-interest student loans."
Of course, you should always exhaust your federal student loan options before turning to private loans or home equity products for the protections they offer, like income-driven repayment plans, deferment and the potential for student loan forgiveness.
Consolidating high-interest debt
Home equity loans and HELOCs typically have significantly lower interest rates than credit cards, so consolidating your high-interest debt may result in lower monthly payments and interest charges. "This can make it easier to manage debt and save money over time," says Carey.
When borrowing from your home equity may be a bad idea
While your home equity can be a convenient way to access cash for various purposes, sometimes it's not a wise option, including in these situations:
Spending on nonessential purposes
"It's not a good idea to be tempted to use your home equity for frivolous purchases," says Ian Wright, director at Business Financing. "Risking your home for the sake of borrowing money for a fancy holiday or upgrading your car is definitely a foolish move."
Borrowing at high interest rates
It may not be wise to take out a loan or line of credit "if your credit doesn't qualify you for the best HELOC or home equity loan," advises Michael Micheletti, chief communications officer at Unlock Technologies. "We're seeing additional credit tightening, which will make it more difficult for homeowners to qualify for loan products."
Tapping equity unnecessarily
Using your hard-earned equity may not be ideal if there are better options available. "For example, student loans may be a better option to pay for college depending on interest rates and circ*mstances," says Kendall Meade, a certified financial planner at SoFi.
Ways to tap into your home equity
Here are some of the ways you can withdraw home equity for various needs:
- Home equity loan:Typically, home equity loans come with a fixed rate and allow you to borrow a lump sum of money. These loans use your home as collateral to secure the loan.
- Home equity line of credit (HELOC): Much like a credit card, this revolving credit line enables you to borrow funds as needed up to your approved limit.
- Cash-out refinance: With a cash-out refinance, you replace your current mortgage with a new, larger one—ideally with a lower interest rate. You can pocket the difference in cash at closing and use it for nearly any legal purpose.
- Reverse Mortgage: Reverse mortgages are designed to help seniors age 62 and older convert some of their home equity into cash.
Do your due diligence before proceeding with any loan or credit product, as each comes with its own benefits and downsides. Learn more about your home equity loan and HELOC options here today.
The bottom line
Lenders typically require you to have at least 15% to 20% equity to qualify for a home equity loan or HELOC. If you have substantial equity in your home, you might consider using some of it to consolidate high-interest debt, renovate your home or any other purpose. Remember, however, these equity options are second mortgages that are collateralized by your home, so if you fail to make your monthly payments for any reason, it could lead to foreclosure.
