As a homeowner, you can think of your home as a resource for future financial security. Each month's mortgage payment builds up your equity a little more. The good news is that you can access that equity when you need it. Home equity loans or lines of credit provide the key.
Home equity basics
There are two main ways to access your equity. A home equity loan involves borrowing a percentage of your equity in a lump sum that's typically paid back in fixed monthly installments over a set period of time. A home equity line of credit (also called a HELOC) is more like a credit card; the difference, however, is that a HELOC is secured debt (debt that's backed by collateral) and a credit card is unsecured (debt that isn't backed by collateral). For a HELOC, you'll be approved for a maximum amount that you can draw against to make purchases. At Navy Federal, you can access your funds online, by writing a check, by visiting a branch or by using your Home Equity Line Platinum credit card. You'll pay back what you use plus interest.
These types of loans are attractive because they may offer lower rates than credit cards or unsecured loans, and the interest may be tax-deductible.1 However, it's important to keep in mind that you're pledging your home in exchange for the loan or line of credit, putting it at risk if you spend more than you can afford to pay back.
When it's a good idea and when it's not
Renovations are among the most common uses of home equity loans or lines of credit. Theoretically, such improvements may increase the value of your home and may increase your equity further once the loan is repaid. However, keep in mind that not all improvements boost your home value and market prices can fall, erasing the value of your improvements.
Home equity may be a way to borrow for college, as the interest rate may be lower than private student loans and the maximum loan amount higher. A line of credit may be particularly useful for parents whose children are a few years apart they can use the money for tuition and pay down the balance in time for the next child to enter college.
Paying off debt
Consolidating higher-interest debt from credit cards, car loans and other personal loans is another use of home equity. To put it simply, you're shifting the debt from assorted credit cards or loans, with varying due dates, to a single lender with an established repayment plan and a lower interest rate. Although this option can lower monthly payments when your debt is bundled together, it's important that you make the monthly payments on time and in full. Otherwise, you may be putting your home at risk of foreclosure. This option is best for disciplined borrowers.
Buying a car
An auto loan is usually a better choice than a home equity loan or line of credit. Interest rates tend to be similar or lower, and they usually require little paperwork and fewer fees.
Going on vacation
It's far better to save for near-term wants like vacations or a large-screen TV than to use your equity for something that offers no financial return.