Now that the economy and housing markets are recovering and becoming stronger again, many homeowners are looking at home equity loans and/or lines of credit in order to upgrade their home, pay off debt or make large purchases. Like any loan, there are some great ways to use home equity loans and lines of credit, and some not so great ways to use that money.
What are home equity loans and lines of credit?
Home equity loans are loans which are based on and tied to the amount of equity you have in your home. In a home equity loan, you use the equity in your home as the collateral a bank or lender will often require before loaning you money. You borrow based on the amount of equity you have in your home.
A home equity line of credit, or HELOC, is a loan where a lender agrees you extend you a certain amount of money (or up to a certain amount of money), for an agreed term or period of time and you use your home as your loan collateral. HELOCs are also known as second (or third, or fourth) mortgages.
Some of the most common uses of home equity loans and lines of credit are to finance major, expensive purchases like extensive home repairs, upgrades or remodels, to pay off medical debts, to pay off credit card debts or to fund the cost of college.
What are some good and bad ways to use home equity loans and lines of credit?
Like most loans, the first question to ask is whether or not your interest rate is competitive, low and fair. If you are thinking about using a home equity loan or line of credit to pay for a major purchase like a car, is the interest rate on the home equity loan going to be lower than the interest rate you would qualify for from an auto loan lender?
If you plan to use the proceeds of your loan to make major home repairs, what is your long term plan for your home? If you are likely to sell your home in the next few years, will your local market support the increased asking price you may need to cover the amount you now owe on your initial mortgage plus your home equity loan or line of credit? For example, if all of the homes in your neighborhood sell for between $250k and $275k, you may have a hard time selling a home for $450k, even if improvements and other renovations that set your home apart from others directly surrounding it.
If you plan to use the proceeds of your loan to pay down credit card debt, do you have a solid plan in place to ensure that you do not find yourself in the same financial situation several years down the road, at a point where you may then be unable to pay off your mortgage plus line of credit and new credit card debt?