What Can I Use a Home Equity Loan For?

Having equity in your home, or having your home be worth more on the market than the amount left on your mortgage, opens up all sorts of new opportunities. Finally renovating that kitchen, expanding your deck, funding that business you’ve always wanted to start — the opportunities seem endless!

But while you can technically leverage your equity to pursue anything you please, home equity loans serve some intentions better than others, especially when you consider the potential risk of using your home as collateral: losing your home to foreclosure.

With such high risk, you want to make sure your intentions are worth tapping your equity for. So, to help you do that, we gathered the five most justifiable reasons driving people to leverage the equity in their homes.

But first, as important as it is to understand what you should use a home equity loan for, it’s equally as important to understand what you shouldn’t.

What Not to Use a Home Equity Loan For

As a general rule, avoid using home equity loans for any lifestyle purchases. This means sports cars, boats, vacations, accessories, and any other vanity buys that could be described as fulfilling nothing more than having fun or helping to embody high-status.

Similarly, home equity loans shouldn’t be used as a band aid for an underlying problem. For example, they shouldn’t be used to recover from overspending or living outside of your means. Applying home equity loans to problems like these simply make matters worse.

Common Reasons People Use Home Equity

If there are two questions to ask yourself when considering using a home equity loan, they are:

If you answer “yes” to either of these questions, there’s a good chance that the project is worth using a home equity loan.

With this in mind, five of the most justifiable reasons to use a home equity loan include:

1. Improving your home

As you might guess by the name “home equity loan”, the most common and justifiable reason to use a home equity loan is home improvement.

By improving your home, you kill two birds with one stone: you make a better living environment for you and your family while simultaneously increasing the market value of your home.

It’s worth noting, however, that not all home improvement projects result in higher market value. If improving the value of your home is the priority, you’re likely to have better luck improving any of the following:

People also use home equity loans for home improvement for interest deduction reasons. This is because you can deduct interest paid on mortgages up to $750,000 if you use home equity funds to “buy, build or substantially improve the taxpayer’s home that secures the loan,” according to the IRS.

Keep in mind that interest deduction benefits have changed in recent years and may change depending on your area, so it’s worth doing your own research.

2. Consolidating Your Debts

If you have a lot of personal debts, including credit cards or car loans, you can consolidate your debt with a home equity loan to take advantage of lower interest rates and long repayment terms, lowering (and potentially simplifying) your monthly bills in the process.

However, consolidating personal debts into a home equity loan can mean going from unsecured debts with no collateral required, with missed payments leading only to poorer credit and higher payments, to secured debt with your home serving as collateral, with missed payments potentially leading to the foreclosure of your home.

All this is to say that you’re converting less risky debt with lighter punishment for missed payments to higher-risk debt with heavier punishment (loss of your home) for missed payments. But as long as you’re able to meet payments every month, consolidating debt can be huge money- and stress-savers.

3. Paying for education

During times when mortgage rates are lower than student loan interest rates, it can sometimes make sense to use home equity loans over student loans to pay for education. Beyond just saving money on lower interest rates, you can also save money by taking advantage of longer terms in some cases.

Although if you don’t see the recipient’s education being reinvested back into your home (such as when paying for a child’s education), using a home equity loan can add unnecessary stress and risk that don’t exist with regular student loans.

4. Funding a business

If you want to fund a business that you foresee making you successful and increasing your means, and therefore, your ability to pay off your loan, then using a home equity loan to start or fund a business is perfectly justifiable

Depending on your needs, a home equity loan may not be the most ideal choice out of all the equity options. For example, if you foresee needing cash at sporadic points throughout the building of your business, a home equity line of credit (HELOC) that allows you periodically pull out only as much as you need would make more sense than a traditional home equity loan, which gives you a lump sum right off the bat.

Although keep in mind that, although you’re only charged interest on however much you withdraw from your HELOC, they have variable interest rates, meaning that your payments could rise in the future.

5. Paying for emergencies

While this reason doesn’t necessarily answer yes to either of the two questions posed at the beginning of this list, many people opt to secure themselves and their families by using a home equity loan as an emergency fund, giving them access to cash should an expensive emergency or sudden loss of means occur.

Given the sudden nature of most emergencies, setting up a HELOC usually makes more sense than using a home equity loan. With a HELOC, you can quickly withdraw only as much as you need when an emergency occurs.

Takeaway

When deciding whether or not to use a home equity loan, first make sure that you’re not going to use the loan for a lifestyle purchase (e.g., a new jet ski) or band aid to fix an underlying spending problem (e.g., trying to maintain a lifestyle outside of your means).

If you pass this test, then try to understand if your intended use of the loan is justifiable by asking yourself the following two questions:

If you answer “yes” to either of these questions, or you share any of the five reasons listed above, that’s great! A home equity loan will probably serve you well.