5 reasons to utilize your home equity — with a lot of caution

Borrowing against the equity in your home often can be a good way to get access to cash quickly. You have several loan options, such as a cash-out refinance, home equity loan or home equity line of credit, but you need to have a good reason for tapping the equity in your home before deciding on one.

■ Use the equity to improve your home

Home improvement is one of the main reasons borrowers will take out a home equity loan or home equity line of credit. Besides making your home more comfortable in which to live, the improvements to your home will increase its value should you sell it.

But if you plan to sell the home, you need to be mindful of the types of improvements you are making to it.

The most common mistake is when homeowners use their home equity to make upgrades like a large TV or swimming pool that do not really increase the value of the home, said Rick Sharga, executive vice president of Ten-X, an online real estate marketplace.

“If you’re thinking about selling your house soon, you want to be cautious about how much you spend on what because there’s a limit to how much you can get over the market value on a house,” Sharga said. “Most real estate folks will say new paint and carpeting, and maybe some upgrades to the kitchen or bathrooms help the value of the house.”

■ Use equity as a student loan

A home equity loan or home equity line of credit also can be a good way to fund a college education because the interest rate might be lower, depending on the type of student loan financing available.

“Paying for education to potentially put yourself in a higher income bracket, that’s a huge positive for using home equity,” said George Pantelaras, director of consumer direct/Internet production at Planet Home Lending LLC.

Before tapping the home equity, look at all of your student financing options, as well as the terms and interest rates. Because your house is securing the home equity line of credit or home equity loan, you could lose the house if you default, while defaulting on a student loan only hurts your credit.

■ Use equity to pay off credit cards

Homeowners often will use their home equity to pay off other personal debt like a car loan or a credit card. A home equity line of credit or a home equity loan sometimes can be a way of consolidating your debt to a lower interest rate.

But this can become dangerous when the homeowner adds on even more credit card debt after taking out a home equity line of credit to consolidate the old debt.

“If you’re planning on tapping home equity to pay off debt, there better be a good management plan in place,” Pantelaras said.

There are also closing costs involved with getting a home equity loan or home equity line of credit, so you need to look at how much it will cost you overall to borrow against your home equity.

■ Use equity as an investment

Some homeowners use their home equity to invest in the stock market or in real estate properties to get a higher return than what they pay on the interest rate. This has its risks because there are no guarantees that the stock market will outperform the cost of the home equity line of credit or home equity loan.

Similarly, if you use home equity to invest in real estate, there’s no guarantee that investment property will sell at a price worthy of the cost it might take to increase the value of that property.

“People tend to sometimes overvalue a property they want to invest in or underestimate the costs involved,” Sharga said. “It’s really abut financial management and whether it makes sense to start with other investors or real estate professionals.”

■ Use equity for other personal needs

Most lenders agree that the worst reason to tap your home equity is for unnecessary personal spending like an extravagant vacation, car or boat.

“These were the things people got in trouble with during the housing market boom,” Sharga said. “They used their house as an ATM.”

Simply put, don’t overspend and don’t overborrow when it comes to your home equity.