When you bought your home, did you think of it as an investment for your financial future? Maybe you were focused on finally getting a backyard or having enough bedrooms to grow your family. Or perhaps you were tired of annual rent increases and wanted a fixed, predictable housing payment. Those are all great reasons for buying a home, but the wealth-building power of homeownership is another major, and sometimes overlooked, benefit.
Over the past five years, home values have grown an average of about 7.5% each year.[2]
For example, if your home was valued at $250,000 in 2016 and grew 7.5% each year since then, it would be worth over $350,000 today! That’s an equity gain of more than $100,000, not including any reduction in principal you’ve made through regular mortgage payments.
So, what can you do with all that home equity?
Instead of sitting on your home equity, you can put it to work for you by converting it into cash through a cash-out refinance or home equity loan. But that doesn’t mean you should run out and buy a luxury car or go on a big shopping spree. Because tapping equity requires you to pledge your home as collateral, it’s important to use your home equity wisely as a means to improve your financial situation.
Here are four smart ways to use your home equity:
1. Make home improvements that add value.
Reinvesting your equity back into your home through value-adding improvements is one of the best ways to leverage those funds. Projects like adding a bathroom or renovating the kitchen not only make your home more comfortable now, but also can pay for themselves by increasing the home’s value down the road. Of course, your return on investment (ROI) depends largely on what type of project you take on. Check out which projects have the highest ROI.
2. Pay off high-interest debt.
The average credit card APR is over 16%.[3] If you’re carrying a hefty amount of credit card debt, it can be very difficult to pay it off due to compounding interest. Mortgage loans, on the other hand, have much lower interest rates. Using your home’s equity to pay off your credit card debt can save you money and help you pay down that debt faster, since you’ll be rolling it into a new payment at a much lower interest rate. You can also consolidate other high-interest debts such as student loans or personal loans.
3. Pay for college.
Higher education is an investment in your (or your child’s) future, but with soaring tuition costs, paying for college isn’t cheap. In some cases, you may be able to score a more competitive rate on a home equity loan compared to a student loan. The downside is, you risk losing your home if you can’t make the payments, so this is an option you should consider carefully.
4. Invest in real estate.
Whether you want to buy an investment property or a vacation home, you can use your home equity to fund the purchase. Depending how much equity you have, you may even be able to purchase the home with cash. If you buy an investment property that you plan to rent out (or if you intend to rent out your vacation home when you’re not there), you’ll be investing your home equity into an income-producing asset, which can generate a positive cash flow.