Home equity is a beautiful thing. It can be looked at as a long-term strategy for financial health, making it important for homeowners to protect.
If you're considering tapping into your hard-earned equity, there are some important things to take into account. After all, you've spent years building up that amount; you want to ensure it's going to the best possible use.
Here are three great uses for home equity, and three uses that may seem like a good idea but can significantly damage your long-term financial health!
Before we delve into equity do's and don'ts, let's first have a crash course in equity.
Home equity represents the amount of the home that you own.
How do you calculate home equity? By subtracting the amount you owe on your mortgage from the appraised value of the home. For example, let's say your home has been appraised at $500,000, and you currently owe $200,000. You'd have $300,000 in equity.
You can increase your equity by making a sizable down payment, paying down your mortgage, and increasing the value of your home. Did you know that you can also lose equity? If the market in your area takes a hit, the value of homes could drop, which would then affect your equity. You could also lose some equity if you don't keep up with maintenance and your house falls into disarray, thus reducing its appraised value.
Now that you know why equity is important, how to calculate it, and how it fluctuates, it's time to review the best ways to use your home equity.
- Debt consolidation
- Major expenses
If you've budgeted and have been working on paying down your debts with little progress, it's time to consider using your equity to settle up all of your accounts. A cash-out refinance may be the way to go!
You must have equity in your home to be eligible for a cash-out refinance. How much equity that is required is up to the lender, but many require at least 20%. A cash-out refinance essentially allows you to borrow more than what you owe on your mortgage, pay off the mortgage, and pocket the difference.
Since this can be a considerable amount of cash, it's best to use this debt consolidation solution when you have a large amount of debt that you haven't been able to get control of. It doesn't make sense from a financial standpoint to utilize a cash-out refinance to, say, pay off a $1,000 credit card bill.
Consolidating your debt can be an extremely smart move to make, as it can help protect your long-term financial health.
By funding your high ROI home renovation projects with a cash-out refinance, you can essentially use your equity to help build more equity!
Tapping into your equity can help you cover the cost of major remodeling projects and can help make your home more attractive to buyers when the time comes to sell. Just as with debt consolidation, a cash-out refinance is designed to give you a substantial amount of cash, so isn't suited for those looking for an extra $500 for some home decor.
If you are planning on using your equity for a home renovation, it's important to know that there are projects can that hurt your home's resale value. If you plan on selling down the road, be sure to avoid low ROI home renovations and instead focus on in-demand home features buyers are looking for!
Paying for your child's college tuition or covering a major medical expense can be great uses for your home equity. Using your equity can help significantly reduce the financial burden you're feeling while keeping you out of debt.
Again, it's best to ensure it's a necessary expense, as you'll be tapping into the equity you've spent years building.
It can be tempting to use your equity for a variety of things, as it's just sitting there. Try to remember that home equity is a long-term strategy for building wealth. You're in it for the long haul, so fight the temptation to use it for the following situations!
- Living expenses
- Gambling, stock market
Day-to-Day Living Expenses
Tapping into your equity shouldn't be taken lightly, especially since you'll be cashing out the value you've spent years building. For that reason, using your home equity for day-to-day living expenses isn't the best use of your funds.
Keep in mind that, as with most mortgage refinance options, there will be closing costs.
Therefore, keep your home equity intact for a time when you really need it, like covering a major unexpected expense rather than your day-to-day living costs.
Who doesn't want a luxurious poolside vacation? If you're in need of a getaway, using your home equity to fund it isn't a great use of your cash-out refi. If you do, you'll be using your investment to fund a one-time trip; a trip that leaves you with no financial gain and doesn't contribute to your financial health.
Instead, consider creating a budget and cutting costs in other areas of spending so that you can save money for your dream vacation. That goes for anything that's considered more of a lavish expense, like a fancy new car or an extravagant wedding.
Playing the Stock Market
Using your home equity to invest in the stock market is a risky game, one that shouldn't be played unless you're extremely knowledgeable in the market and understand how a negative outcome would impact your financial health.
If you're eager to start investing, consider using funds from your savings or even emergency fund. If you can't cover the amount you want to invest, it's best to budget and save for it rather than tapping into your home equity.
Home Equity for a Financial Return on Investment
Remember that the best uses for home equity are the ones that provide for a financial return on investment. If you're interested in a cash-out refinance so that you can consolidate your debt, improve your home, or cover a major expense, always compare lenders! Many closing costs can be negotiated, and with a few quotes in hand you're better positioned to negotiate the most competitive rates for yourself!
At the end of the day, it's your hard-earned equity. Use it how you see fit. Just know that there may come a time when an unexpected expense arises, and many homeowners can fall back on their equity, as they've left it intact. Carefully weigh all of your options before dipping into the amount you've spent years building.