Home improvements are one of the most common reasons home equity is leveraged, and it can make a lot of financial sense. For one, the costs of certain renovations and upgrades may be more than you can afford with your current savings and monthly income. But improvements to your home can also increase its value. If you sell the home later, you might recoup some or all of the money you spent on renovations, or even turn a profit.
2. Consolidate high-interest debt.
If you have large amounts of credit card debt or other high-interest debt, leveraging your home equity can be a great way to reduce the amount of interest paid while consolidating these payments into a single monthly bill.
Most home equity loans offer interest rates that are much lower than credit card rates, as well as other loan interest rates. By leveraging your home equity, you can pay off these debts faster and save money in the process.
3. Pay for college tuition.
Parents looking to pay for some or all of their children’s tuition may want to consider home equity as an alternative to student loans. Depending on the types of student loans being offered, your home equity interest rate could be lower than the student loan interest rate, resulting in a more attractive financing opportunity.
Of course, if you take out a home equity loan, you're becoming the sole party responsible for repaying the debt, whereas student loans can be solely in the name of your children or feature you as a co-signer, instead of the sole borrower. Ultimately, it comes down to your willingness to pay for college tuition, and the interest rates you're able to obtain through student loan servicers as compared to your lender.
4. Purchase an investment property.
If you have a lot of equity built up in your home, you can use that equity to make a down payment on a second property, such as a rental home. This can be an appealing option for diversifying your investments, while using equity to generate its own income. But as with any real estate endeavor, it comes with risks.
When purchasing real estate, you'll need to find a property where the earnings and rent can cover the cost of your loan, plus maintenance to the property. Otherwise, you risk falling behind on your payments, losing money and possibly even losing the second property—as well as your home.
5. Invest in the stock market or other high-yield funds.
Investing with home equity comes with risks, and certain steps should be taken to minimize your liability. For one, take a long approach to investments. Since the stock market is unpredictable, short-term investment strategies using home equity is a dangerous move. If you're going to use this money to invest, make sure you have a long-term strategy in place.
On a related note, if you're going to make long-term investments with this money, consider putting it into an individual retirement account (IRA) where the funds can reduce your tax liability for the current year. This can provide tax relief of hundreds or thousands of dollars, which can then be re-invested or put toward other financial goals. In doing so, you retain income from the current tax year while placing money into a long-term investment strategy.
Home equity is a valuable asset, but make sure the way you leverage this equity is serving your financial goals instead of diverting money to luxury spending. When considering how to use home equity, make sure you can make a strong financial argument for whatever decision you make.