Home equity can be a powerful financial tool, but tapping into that equity for the wrong reasons can be a money trap.
Currently, home owners have ample opportunity to tap their equity whether it’s for the right or wrong reasons. They are sitting on a record amount of equity, and they’ve been borrowing from it less frequently—so the temptation to go ahead and use it is growing.
What will they do—and what will you do with your home equity? A new study from Bankrate.com reveals some of the purchases for which home owners would be willing to tap their equity. The results of this study could offer you insight into which purchases might be worth drawing on your home’s equity, which ones are not and which are better delayed or paid for with traditional financing.
Most agree on home improvement and repairs. Three out of four respondents to the Bankrate survey agreed that withdrawing cash from home equity can be an appropriate way to pay for home improvements and repairs.
Their thinking is generally sound, particularly if the work performed adds value to the home. When a project boosts the home’s value, it adds equity. Also, the new federal tax law allows home owners to deduct from their taxes any interest paid on a home-equity loan or line of a credit (HELOC) that is used to finance projects that add significant value to the home.
The debt-consolidation conundrum. About 44% or respondents said they’d be OK with using home equity to consolidate debt. Experts caution that while this can be a savvy move that reduces interest payments, it works only for disciplined, responsible borrowers. If you borrow against your equity to pay off high-interest debt at a lower rate, only to quickly rack up more debt on credit cards or other expensive loans, you’ve gained nothing except a new monthly bill.
Equity to pay for education. Another 31% said they’d consider tapping home equity to cover the cost of tuition or other educational expenses. That’s not necessarily a bad thing, but it should be a last resort. If you hold federal student debt, your loan probably comes with favorable terms like income-based repayment, forbearance, deferment and possibly even loan forgiveness—but not so with home-equity debt. Also, be sure to apply for grants, scholarships and work-study programs first.
Keeping up with household bills. About 15% said they’d consider pulling equity from their homes to pay household bills—and that number is very revealing. Lower-income earners who make less than $30,000 a year are nearly twice as likely to share that opinion as those making $50,000 to $74,999. Higher earners are even less likely to do so. Experts interviewed by the study’s authors surmise that this statistic reveals just how thin many of America’s lower-income households are spread financially.
When home equity isn’t the answer. Thankfully, only small percentages of respondents think home equity is an appropriate way to finance vacations, elective plastic surgeries, investments or depreciating big-ticket items like boats. Big-ticket and luxury items often come with incentives like low- or no-interest loans for the most qualified buyers, which are much better ways to finance those purchases.
