When does a home equity loan make sense?

Borrowing money comes with a unique set of challenges in today's economic landscape. For starters, the Fed's benchmark rate is still paused at a 23-year high, which has caused interest rates on lending products, like credit cards and personal loans, to stay elevated. And, persistent inflation has also led some experts to push back their rate cut expectations for 2024, so it's unclear if or when we'll get some relief from today's high-rate environment. 

But there are still a few ways to borrow affordably right now. For example, homeowners currently have a unique opportunity to leverage the equity built up in their properties by using a home equity loan. And, the average homeowner currently has around $299,000 worth of home equity — approximately $190,000 of which is tappable — giving them a significant source of funds to borrow from. Home equity loan rates are also relatively low today compared to other lending products, averaging 8.59% (as of April 16, 2024).

However, taking out a home equity loan is not a decision to be made lightly. It's essential to carefully consider the circumstances in which a home equity loan can make the most financial sense. 

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When does a home equity loan make sense?

Here are a few scenarios where a home equity loan may be the best option:

When you're making home renovations or improvements

One of the most common reasons homeowners consider a home equity loan is to finance major home renovations or improvements. Whether it's a kitchen remodel, an addition or energy-efficient upgrades, a home equity loan can provide the necessary funds to increase the value of your property. 

Using your home equity funds for this purpose can also be a strategic move, as the improvements made to the home can potentially lead to an increase in equity and an uptick in the home's resale value, making the loan a worthwhile investment. And, the ability to deduct the interest paid on a home equity loan used for home improvements can further enhance the financial benefits of this approach.

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When you need or want to consolidate debt

If you're burdened with high-interest debt, such as credit card balances or personal loans, a home equity loan can be an effective way to consolidate those debts. By using the equity in your home as collateral, you can often secure a lower interest rate than you're paying on your current debts, which can lead to significant savings over time. 

For example, the average credit card rate hovers near 21% currently, but the average home equity loan rate is below 9%. So, if you're able to lower your interest rate by rolling your high-interest debt into a home equity loan, that move may help you pay off your debts more efficiently and potentially improve your credit score over time. 

To cover college tuition and education expenses

If you're looking to finance your children's or loved ones' educations, a home equity loan can be a viable option. That's because the interest rates on these loans are often lower than those on private student loans, making it a potentially more affordable choice — and home equity loans offer different terms than student loans, too. 

This route can be particularly useful for families who have exhausted other educational funding sources, such as scholarships, grants and federal student loans. By leveraging the equity in your home, you can provide your children or loved ones with the resources they need to pursue higher education without overburdening your own budget.

When you need emergency funds for unexpected expenses

Unforeseen expenses, such as medical bills or major car repairs, can put a significant strain on your financial resources. But a home equity loan can serve as a safety net, providing access to funds when you need them most. 

This can help you avoid dipping into your savings or relying on high-interest credit cards, which can have long-lasting financial consequences. Having the funds from a home equity loan on hand can also provide peace of mind, knowing that you have a reliable source of funds to draw upon in times of financial hardship or unexpected emergencies.

To take advantage of investment opportunities

If you've identified a compelling investment opportunity, such as a real estate venture or a promising business opportunity, a home equity loan can provide the necessary capital to take advantage of it. This can be a smart strategic move, as the potential returns from the investment may outweigh the cost of the loan if successful. 

However, it's crucial that you carefully evaluate the risks and ensure that the investment aligns with your long-term financial goals. Investing the proceeds from a home equity loan can potentially yield higher returns than the loan's interest rate, but it's essential to thoroughly research and understand the investment before committing your home's equity.

What to know about borrowing from your home equity

It's important to note that while a home equity loan can be a useful financial tool, it's not without its risks. By using your home as collateral, you're putting your property at risk of foreclosure if you're unable to make the loan payments. And, if the value of your home decreases, you may end up owing more on your home than it's worth.

To ensure that a home equity loan makes sense for your specific situation, be sure to carefully evaluate your financial goals, budget and the potential risks associated with what you're using the funds for. You may also want to consider consulting with a financial advisor or a seasoned mortgage professional to better understand the implications and explore any alternative options that may be more suitable for your needs.

The bottom line

A home equity loan can be a valuable financial tool in many circumstances, as this type of funding is typically affordable compared to other borrowing options. Still, it's crucial to weigh the benefits against the potential drawbacks. By understanding the circumstances in which a home equity loan can be the right choice, you can make an informed decision that aligns with your long-term financial well-being.