And when you should think twice about tapping into it.
Drawing on the equity in your home is an easy way to access cash quickly. But as simple as tapping into this asset sounds, it should be done responsibly and with caution – we’re talking about borrowing against the roof over your head after all.
So, how should you use the value built up in your home? Here are five ways to leverage home equity and when you should think twice about spending it.
1. Make home improvements.
Home improvement is a common and practical use of a home equity loan. Not only do you get the benefit of a more comfortable, stylish living space, but depending on the type of upgrade, you also can increase your home’s value.
Some smart home improvement projects that result in great returns are minor bathroom remodelling, landscaping, and minor kitchen renovations.
If you’re using equity for home improvement be cautious not to over-improve. Big upgrades (additions, extravagant kitchens) that aren’t on par with the overall value of your home or with other homes in your neighbourhood will be less likely to recoup the money spent on the project.
2. Consolidating high-interest debt.
Home equity can be an effective tool to reign in personal debt by drawing on it to consolidate high-interest balances (credit card debt and a car loan for example). Consolidating your debt gives you the advantage of a single, fixed monthly payment that’s often at a lower interest rate than revolving credit card debt.
But beware. Don’t go climbing out of debt only to pile it on again. A pitfall of leveraging home equity to eliminate debt is that repayment isn’t the result of smarter spending habits often needed to break debt cycles.
Be sure to evaluate how to maximize your budget to avoid additional debt accumulation.
3. Invest in education.
A home equity loan or line of credit can be a good way to fund your child’s post-secondary education. One of the benefits? Potentially securing a lower interest rate compared to other student loan options. However, it’s always wise to explore all options for student loans and understand their terms. Defaulting on a student loan might mean having to rebuild your credit score, but doing so on your home equity loan can result in losing the roof over your head.
Consider exploring a blended approach to paying for your kid’s education, taking advantage of a Registered Education Savings Plan (RESP), education-specific government incentives like the Canada Education Savings Grant, in addition leveraging home equity.
4. Emergency fund.
Life’s uncertainty is why an emergency fund is an important piece of your financial plan. As uncertain as life can be, it’s also unrealistic for many people to build up a reserve of readily available funds for emergencies once all of the bills are paid.
Using home equity to cover unexpected expenses is an acceptable reason to borrow if you have an emergency.
5. Investing in real estate.
Exercise caution here. While investment properties can be lucrative, using home equity to invest in real estate carries risk with no guarantees of securing decent returns - you can’t be certain that any property will bring in more than what you put into it.
If you decide to use equity to invest in real estate, be sure to consult knowledgeable investment advisors and real estate professionals.
What are the ‘not so good’ reasons to tap into your home equity?
Having access to the money your home equity affords comes with temptations and should be handled responsibly.
Financial experts agree that the worst reason to tap into your home equity is to pay for unnecessary wants. Extravagant vacations or depreciating assets like a new car, boat, or snow machine don’t have long-term financial value or return potential.
The bottom line.
Make responsible choices when it comes to borrowing against your home. Consider what it took to build the equity you have and what the most beneficial use of that money will be.
Only borrow what you need and don’t overspend.
As always, speak to a Northern Advisor before making important decisions about leveraging your home equity.
