As the market recovers and home equity is once again on the rise, you may be tempted to tap that wealth and use it elsewhere. This is borrowing from one asset (often your home or a 401(k) account) to fund something else. If you have a steady, reliable source of income and are confident you will be able to repay the loan, this can allow you to capitalize on a low interest rate, tax-deductible option. Using a home equity loan or line of credit can be a useful and cost-effective tool for responsible borrowers, but it comes with risks. While it can save you on interest, offers fewer monthly payments and allows higher loan limits, it doesn’t necessarily solve your debt problem and puts your home at risk if you can’t pay it back. This isn’t a good source of funding for a vacation or new fancy car, but there are some instances when it can make sense to use your equity.
1. Home Update or Improvement
Improving your home and increasing its value are often good reasons to use your home equity. If you bought a home that needs an addition, garage, finished basement, cosmetic improvement, or kitchen or bathroom updates, tapping into your home equity can provide the necessary funds. The opportunity is even more attractive if your home has recently risen significantly in value so you have a larger borrowing cushion. The same usually applies when it comes to purchasing rental real estate or investment properties.
2. Credit Card Debt
Ridding yourself of personal debt is a popular use of home equity or cash-out refinance that can potentially pull you out of hot water. But even if it seems to make sense when you run the numbers, freeing up unsecured debt like credit card debt for debt secured by your home is usually a bad idea. If you can’t pay back the debt, you are now at risk of potentially losing your home. The circumstances in which this is a good idea are limited. Of course, failing to pay back either debt can damage your credit. If you want to see how your debt is affecting your credit, you can check your free credit report summary on Credit.com.
Some retirees use home equity to meet their needs if their retirement funds, Social Security and investment returns are not covering everything. It’s not necessarily a good idea to count on your home equity for retirement, but this can be helpful if you plan to take a reverse mortgage.
Before you tap your home’s equity, it’s important to evaluate the decision carefully, and it can be helpful to consider consulting a financial planner or adviser before making the leap.
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