The value of your home can decline
Although you may feel better knowing that you could access your home equity in case of an emergency, it still makes smart financial sense to set up and start contributing to an emergency fund.
Why use home equity for this: If you have an emergency and no other means to come up with the necessary cash, tapping home equity may be the answer.
Why you should skip it: The lengthy application process associated with accessing home equity may not be ideal for a time-sensitive emergency.
5. Wedding expenses
For some couples, it might make sense to take out a home equity loan or HELOC to cover wedding expenses. According to The Knot’s Real Weddings study, the average cost of a wedding in 2020 was $19,000, down from the pre-pandemic figure of $28,000 in 2019. This doesn’t even include the average cost of the honeymoon.
To pay for this special life event, some couples turn to wedding loans, or personal loans used for weddings. However, the interest rates on these loans are typically higher than interest rates for home equity loans and HELOCs because they are unsecured — not tied to an asset.
Although tapping your home equity could save you money on interest, be careful not to take out more than you need. By having family members contribute or cutting costs on some wedding expenses, you might be able to reduce the cost of your dream wedding.
Why use home equity for this: Using home equity to pay for wedding expenses can be cheaper than taking out a wedding loan.
Why you should skip it: You can lessen how much you borrow by adjusting your wedding celebration, saving up for the big day, and asking family and friends for contributions instead of gifts.
6. Business expenses
Some business owners use their home equity to grow their businesses. If you have a business that requires more capital to grow, you might be able to save money on interest by taking equity out of your home instead of taking out a business loan.
Before you commit to taking this action, be sure to run the numbers on your business. As with using your home equity to purchase investments, a return on investment in a business isn’t guaranteed.
Why use home equity for this: You might be able to borrow money at a lower interest rate with a home equity loan than with a small-business loan.
Why you should skip it: If you haven’t tested out your business, your plan could fail and you’d still need to make payments on what you borrow — regardless of lack of earnings.
Important factors to consider
Even if you have substantial equity in your home and think it’s a good option for financing your home improvement project or consolidating debt, there are a few considerations to be aware of before tapping that equity.
Keep in mind that there’s no guarantee that your home value will increase substantially over time. Your home may even lose value in times of economic downturn or suffer damage from fire or extreme weather.
If you take out a home equity loan or HELOC and the value of your home declines, you could end up owing more between the loan and your mortgage than what your home is worth. This situation is sometimes referred to as being underwater on your mortgage.
Say, for example, that you owe $300,000 on your mortgage but the home prices in your area tanked, and now the market value of your home is just $200,000. Your mortgage would be $100,000 more than the value of your home. If your mortgage is underwater, it’s much harder to get approved for debt refinancing or a new loan with more favorable conditions.