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When you should use your home equity (and when you shouldn't)

If you're making major home repairs or renovations then a home equity loan could be worth it for you. Getty Images

In today's rate environment where it seems like rates are constantly heading upward (the Federal Reserve has raised them 10 times since last March), many Americans find themselves looking for low-interest alternatives. For some homeowners, this may take the form of a home equity loan or a home equity line of credit (HELOC). This unique form of credit can help pay for a variety of expenses — and it doesn't come with prohibitive interest rates or terms.

That said, like any financial product or service, there are better times to use your home equity than not. Below we will break down three times you should strongly consider using your home equity … and three times when it may make sense to look elsewhere.

Start by exploring your home equity options here now to see if it's best for you.

When you should use your home equity

Here are three smart times to use your home equity.

When home prices are high

While rising interest rates may have hurt the real estate market in some parts of the country, they've had little to no effect on other parts. If you're in one of the latter areas of the country and are sitting on a substantial amount of equity (due to a high home value) then it makes sense to act now when you can borrow substantially more than you may be able to if your home value drops. Most borrowers will allow you to deduct 80% to 85% of your home equity, meaning you could have hundreds of thousands of dollars to work with.

When you're planning on using it to make home repairs

If you need money to finance major home repairs and renovations, then it makes sense to use your home equity. That's because the interest on home equity loans and HELOCs is tax-deductible if used for IRS-approved reasons. 

"Interest on home equity loans and lines of credit are deductible only if the borrowed funds are used to buy, build, or substantially improve the taxpayer's home that secures the loan," the IRS explains online. "The loan must be secured by the taxpayer's main home or second home (qualified residence), and meet other requirements."

When the alternative has higher interest rates

Interest rates on home equity loans are likely heading upward amid the overall rate environment. But that doesn't mean they're still not a viable option, particularly if the alternative comes saddled with a higher rate. Credit cards currently hover around 20%. Personal loans are much lower but are still generally in the double digits. Home equity loans and HELOCs, however, may be able to be secured for less than 10% depending on your credit score and history. That difference in rates will add up over time, so be sure to review all of your options before signing on the dotted line.

Ready to get started? Check your home equity options here to learn more

When you shouldn't use your home equity

Here are three times you should probably avoid using your home equity

When you want to buy a new car or to pay for a vacation

Home equity loans are great for very specific purposes. A new car or a vacation doesn't qualify. Remember, when you use this form of credit you're using your home as collateral. If you don't pay it back, you could risk losing your home altogether. Is that really a risk you feel comfortable taking to pay for a new set of wheels or a long trip overseas? Just because you can use your home equity doesn't mean you necessarily should. When it comes to paying for cars or vacations, consider an alternative instead.

When you want to leave your home for beneficiaries

If you're relying on your home as a nest egg for family members in the event of your death, then you should pass on a home equity loan. Remember: A home equity loan directly borrows against the hard-earned money you've built up in your property. If you die before that loan has been repaid, the balance of your home will be short minus that amount. Instead, keep the equity intact and look for other funding options. 

When you haven't established good credit and borrowing habits

If you've put yourself into a financial hole and need help digging out, don't turn to your home equity. You need to first establish good credit and borrowing habits. If you're not yet in that position then borrowing from your last major investment could prove disastrous. Again: Your home is your collateral in these situations. So if you don't think you can realistically repay what you borrowed, don't take the chance. 

The bottom line

Home equity loans and HELOCs can be smart and effective ways for homeowners to finance major repairs and expenses. But they're not for everyone and they shouldn't be used for everything. If your home value is still high or if you need money to make a major home renovation, then a home equity loan is probably worth it. It can also be useful if the alternatives all have higher interest rates. But if you simply want it to pay for a new car or vacation, or if you were planning on leaving your home to family members after you have died, a home equity loan probably isn't your best strategy. Similarly, don't use it to pay for other expenses if you haven't already ended the cycle of borrowing.

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