As you begin to make progress on paying back your mortgage, you’ll start to build what is known as equity in your home. Equity is the amount of value in your home (based on its fair market value) above the amount that you still owe on your mortgage. The equity in your home is good for more than just a benchmark for how well you’re doing with paying off your mortgage, though – you can also use your equity to finance new pursuits. Although there are certain things that home equity is great for, there are other uses that are not recommended. In this article, we will discuss the top five things on which you should not use your home equity line of credit (HELOC). If you want to further discuss safe and sensible uses for a HELOC, consult with your lawyer or financial advisor.
How Should You use Your HELOC?
The traditional “best” use for a HELOC is home improvement. This is basically an investment – using your home equity to increase your home’s value, ultimately making it worth more in the long run if and when you decide to sell. Your HELOC can be used for other things too, but none are as reliable as home improvements. If you are going to use your equity for something else, though, the key is to only get things that you need, and which are within your means and budget. Otherwise, they will almost certainly become bad debt. The following five items are examples of debt that typically goes bad.
1 – Leisure and Recreation
Leisure and recreation should never be funded with a HELOC, as this is a clear sign that you are living beyond your means. As much as you may feel like you deserve that cruise to the Bahamas or trip to Hawaii, the fact of the matter is that if you have to use your HELOC to pay for it, then you definitely can’t afford it. That means that you are high at risk for failing to make necessary payments, and when you miss payments on a HELOC you are risking your home since it stands as collateral for the debt. Don’t risk your home for the fleeting fun of a vacation.
2 – Automobiles
You should also avoid using a HELOC to finance a car purchase. First of all, the interest rates on car loans tends to be lower than the interest rate on a HELOC these days, so you’re better off just getting an auto loan. What’s more, the auto loan will be secured by the car, whereas HELOCs are secured by your home, as mentioned above. If things go south for you financially, what would you rather lose – your car or your house? In addition, since cars invariably depreciate over time, a HELOC may actually run longer than the useful life of the car, meaning you’ll be making payments on a car after it becomes virtually worthless.
3 – Paying Off Credit Cards
While it is possible that the interest rates on a HELOC will be lower than those on your credit cards, it may still be unwise to rob Peter to pay Paul in this manner. As has been the recurring theme so far, using a HELOC to pay off credit card debt is actually upgrading your risk. If you had large credit card bills that you were having trouble paying, then the problem is not likely to go away after you refinance your debt to a HELOC. The only significant thing that will change is that now your house is at risk if you fall behind on your payments.
4 – Paying for School
You should always rely on student loans to pay for your kids’ college before resorting to a HELOC. Not only is the familiar risk of using your home as collateral there again, but you could also find yourself having to pay off the HELOC well into retirement, which is less than optimal. On top of this, your child taking out a student loan makes much more sense than you using a HELOC, as they have an entire working life in front of them to pay off the loans, whereas you are approaching the end of your income-earning years and shouldn’t be saddling yourself with additional debt.
5 – Buying Property
Real estate investment is always a gamble – you’re hoping that you will be able to sell property for more than you paid or owe on it, thereby turning a profit. In times of economic strength, this plan is frequently borne out. However, you can never be sure when the market will turn, or when a project will otherwise prove less profitable than expected. Therefore, it is ill-advised to use your home as collateral when speculating in other properties. Don’t tie the place you live to the vagaries of the real estate market.
A HELOC can be a great tool for making the improvements necessary to increase the value of your home. However, you should resist the temptation to treat your home’s equity like a piggy bank and dipping into it for frivolous or risky undertakings. Discuss any plans for taking out a HELOC with your lawyer and financial advisor before making a commitment