4 good ways to use your home equity

Hand holding pen and signing mortgage

Don’t use your home equity like an ATM! That’s part of what caused the subprime mortgage crisis, and it’s not good for your personal wealth, either.

But if you don’t use your home equity line to pay monthly bills or to help you splurge on a vacation, a new wardrobe or other tempting items, can you use your home equity at all?

You can -- if you’re careful and selective about which projects make the cut.

Don’t use home equity to pay off credit card bills unless and until you’ve addressed the overspending problem that created those bills in the first place. Fail to address the root issue, and you’ll have both a home equity loan and new credit card bills.

Pay off debt. If you can reform your spending habits, a home equity line of credit can help you consolidate your debt so that you make one monthly payment instead of many.

You’ll also typically pay a lower rate on a home equity loan than you will if you carry a balance on a credit card account, and the interest you pay on a home equity loan may be tax-deductible, depending on your tax situation.

Consider using home equity to fund items with values that last beyond the term of the loan.

Pay for school. Educational loans might qualify, though it’s important to consider the student’s future earning prospects, as well as parents’ ability to pay off an educational home equity loan before retirement or before they need the money for some other reason.

Buy a car. If you finance a new or used car with a home equity loan, try to pay off the loan as quickly as you can -- certainly before you need another car. Cars lose value over time -- old ones are worth less than new ones -- and you don’t want the loan to have a higher balance than your car’s value.

One thing to remember: You can probably find lower auto loan rates than what you'd get on the average home equity line of credit.

Renovate your home. Many people finance home improvements with home equity money, which can be a solid decision.

Remember, though, that not every home improvement pays for itself in adding value to your home. Additional bathrooms and remodeled kitchens often add as much or more than their purchase price to your home’s value. A real estate agent or a home value web site such as Zillow.com can tell you more about what makes one home sell for more than another in your area.

Plan to keep a cushion of at least 20% of the equity in your home. You’ll pay higher interest rates if you borrow more than that, and you’ll remove an important source of emergency funds.

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