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A home equity loan can be used for anything from paying off high-interest credit card debt, to home improvements to buying a car. The best uses of a home equity loan improve your financial situation, your home or your future and these include debt consolidation, home improvement and education. Your money is invested in something that grows. Poor uses of a home equity loan are to buy a car or to pay for living expenses - the money is spent on something that depreciates or does not create an asset.
Here are some popular uses of home equity loans:
Debt Consolidation
Using a home equity loan to replace various credit card and other high-interest debt has several advantages. The interest rate you pay on your average home equity loan is lower than the interest rate you will pay on your average credit card by 7% to 10% or more. The interest you pay on a home equity loan is tax deductible where as the interest you pay on credit card debt is not. A single payment on a home equity loan can simplify paying several credit cards with different lenders and staggered payment times.
Let's say you have $20,000 in credit card debt at 18%. If you are making a monthly payment of $450 (50% more than the minimum payment of $300), it will take you 6 years and 1 month to pay off that debt and you will pay $13,045 in interest. Using a home equity loan at 8%, you can make the same payment and pay off that debt in 4 years and 4 months and pay only $3,732 in interest. This means that you have saved over $9,000 in interest. With the home equity loan scenario, if you are in a 30% tax bracket, you will also save over $1,000 in taxes on the $3,732 you will pay in interest.
A home equity loan can also help make spiraling credit card debt more manageable by spreading out the payments over a longer period of time. If a home equity loan is used for this reason, you should consider the fact that you may be paying more in interest over the long run if you make smaller payments.
When a home equity loan is used for debt consolidation, you should have a plan for how you will avoid incurring future debt.
Home Improvement
A home equity loan used for home improvement, repairs or upgrades can give you a tax sheltered way of increasing the market value of your home.
If you make home improvements with the specific intent of increasing your property value, (as opposed to making it more comfortable to live in), make sure that the renovation will add the value you are looking for. For example, a kitchen renovation might recover the money spent and more, where as adding a pool might not.
While a home equity loan in most cases decreases your home equity, when used wisely for home improvements, a home equity loan can actually increase your home equity by increasing the market value of your home beyond the value of the loan.
Education
A home equity loan can be invested in your future by paying for an education. The invested money pays for itself with a higher paying job and a brighter future. The money can also be used to pay for your children's education if you do not qualify for government loans. A home equity loan used to pay for a child's college education can be structured in a way that you will pay only the interest while the child is in school with the hope that your college graduate can pay the balance of the loan.
Major Purchases
You should not use a home equity loan to buy a car, a boat, a vacation or some other big-ticket item. Save until you can afford it. The problem is that you incur debt and decrease your home equity to buy these luxury items that only depreciate over time. However, using a home equity loan to buy a car would make the interest paid tax deductible where as the interest paid on a regular car loan is not.
Business/Investments
A home equity loan can be used to start or fund a business and it can also be used for investing in other property or the stock market. We advise caution when using the money for these purposes. While these ventures can certainly succeed and be profitable, they carry a great degree of risk and can cost you your home.
Lenders always ask what the home equity loan is for. You should be aware that some lenders will not give out home equity loans for business and investment purposes as they feel that this is too risky.
Living Expenses
A home equity loan should not be used to fund living expenses. If you are spending more
money than you are bringing in, and you need a home equity loan for this to continue, this is a very bad sign. Funding living expenses can cost you your home.
Miscellaneous
A home equity loan can be used for anything and some less common uses include paying for medical treatments and emergencies or helping out a family member.
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