Home equity loans traditionally have been used for home improvement projects because there is a friendly relationship between your home’s equity and improvements made to your home. You’ve heard of a vicious cycle? Well, this is a friendly cycle.
In other words, let’s say you have $50,000 in equity in your house. Using a home equity loan, you use this $50,000 to put on an addition, add new siding, and remodel the kitchen. These projects increase the value of your house and add yet more equity to your home.
When to Use the Loan and When Not
My personal opinion is that lenders push home equity loans onto customers with slick marketing campaigns, even when the customers should pursue other financing options.
Before the financial crisis of 2008, lenders practically threw money at homeowners, encouraging them to build decks, sunrooms, and refurbish bedrooms into offices. Anything to get a sale. Now, that fervor has thankfully waned.
I would not take out a home equity loan for any of the above-listed projects because they are classically low-return projects upon resale. Instead, look at the loan as an investment in your house. Are you making a wise investment or not?
Wise investments fall into two categories:
- Resale: These equity-financed jobs return high resale value (kitchen remodels, for example).
- Emergency: I call these emergency projects because not doing them will further damage your house. Roof replacement isn’t a high resale value project. But if your roof is bad, ignoring the problem will only create larger problems inside the house.
Caution: this process does not continue indefinitely. Your home’s equity is also dependent on other factors unrelated to your renovations. But the relationship between equity and your home’s condition is certainly one that you should leverage.
Also with home equity loans you can typically pull out more money, and at lower interest rates, than with other types of financing options. Be careful, though, because home equity loans tend to be tied to variable interest rates. And because they are variable, they can always “vary” in the upward direction.
Fixed-rate home equity loans are available, but you will have to ask your loan consultant about them. The fixed-rate is higher than the variable rate and is not usually advertised. If rates appear to be steadily rising, it may be a good idea to consider the fixed rate.