What You Can Use a Home Equity Loan for (and What to Avoid!)

As a homeowner, you can think of your home as a resource for future financial security. Each month’s mortgage payment could build up your equity a little more. You also may be able to access your home equity if you need it—whether you want to improve your home, fund other important purchases or pay down high-interest debt. Home equity loans or lines of credit provide the key.

Let’s start with a quick overview of the basics.

What is home equity?

Home equity is the portion of your home that you own: the difference between what your house is worth and how much you owe on your mortgage. 

Imagine you buy a house for $200,000 with a $20,000 down payment. That means you start out with $20,000 in equity (because you own that portion outright). Over time, as you make mortgage payments, the amount you owe goes down and your equity increases. 

Another way your equity can grow is if the value of your home goes up. For instance, after a few years, your mortgage might be down to $150,000. Meanwhile, your house might be worth $220,000 now. This would mean your equity has grown to $70,000 ($220,000 value minus the $150,000 remaining on your mortgage).

How can I access my home’s equity?

There are several ways to access your equity. Two of the most common are home equity loans and home equity lines of credit (HELOCs).

• A home equity loan is a type of second mortgage, or lien, that involves borrowing a percentage of your equity in a lump sum that’s typically paid back in fixed monthly installments over a set period of time. These types of loans are attractive because they typically offer lower rates than credit cards or unsecured loans. That means there’s less risk to lenders because you’re borrowing against the part of your home you already own.
• A home equity line of credit is more like a credit card because you’ll be able to access your funds as you need them, using your home’s equity as collateral. With a HELOC, you’ll be approved for a maximum amount that you can draw from. Keep in mind that HELOCs often have a variable rate.

A home equity loan is a good choice if you have a specific project with a known cost. For example, you might be doing a kitchen renovation that you know will cost $20,000. You’ll receive the entire $20,000 upfront, allowing you to budget effectively and get the project done.

On the other hand, a HELOC is better suited for situations when you aren’t sure of the exact amount of money you’ll need. With a HELOC, you’ll have access to a credit line up to a pre-approved maximum, secured by your home equity. You only pay interest on what you use. Navy Federal even offers a convenient HELOC Platinum Card that you can use just like a credit card.

Keep in mind, though, that when you use a home equity loan or HELOC, you’re pledging your home in exchange for the loan or line of credit, potentially putting it at risk if you spend more than you can afford to pay back. 

Before signing on the dotted line, make sure you fully understand the loan terms: the interest rate (fixed or variable), repayment schedule and any potential fees associated with origination, appraisal or prepayment. 

Can a home equity loan be used for any purpose?

Although home equity loans offer a tempting wellspring of funds, they’re best suited for strategic purposes. Because these loans leverage the equity you’ve built in your home, they often can yield more favorable interest rates than other types of lending solutions. 

Home equity loans are particularly suitable for investments that can increase your net worth over time, rather than for everyday expenses.

The 3 Best Uses of a Home Equity Loan

1. Financing larger home improvement projects.

Home renovations are among the most common uses of home equity loans. Popular projects include kitchen and bathroom remodels, which can range from $10,000 to $50,000 or more, depending on the size and scale of the renovation. These upgrades not only improve your living space but also potentially increase the value of your home. 

Theoretically, such improvements may increase your home’s value, which could increase your equity further once the loan is repaid. However, keep in mind that not all improvements boost your home’s value. Plus, housing market prices can fall, which would erase the value of your improvements.

Also, depending on where you live or the improvements you make, there’s a chance you may be able to write off the interest you pay on the loan.¹ This potential tax benefit adds to the overall appeal of using a home equity loan for these types of projects.

2. Paying off or consolidating debt. 

Consolidating higher-interest credit card debt, as well as debts from car loans and other personal loans, is a strategic use of home equity. Specifically, consolidating other debts into a home equity loan could help you secure lower interest rates on your balance due. 

This shift can make repayments easier. For example, you’d consolidate your debt from various sources—that have different due dates and interest rates—into a single loan with a more manageable repayment plan. You also could replace multiple payments with one monthly payment, with a potentially lower interest rate.

Because home equity loans typically offer lower interest rates than many other lending options, consolidating high-interest debt into a home equity loan could significantly reduce the amount of interest you pay over time. A home equity loan could also simplify your budget by combining multiple debts into a single monthly payment, making it easier to track and pay off your debt faster.

However, it’s important to be aware of the risks. Using your home’s equity to pay off debt puts your home at potential risk if you fail to make payments on time and in full. There’s also the risk of falling into the trap of accumulating new debt, which could put you in a worse financial position.

Using a home equity loan for debt consolidation is most suitable for disciplined borrowers who are confident in their ability to manage their finances responsibly. If you’re considering using a home equity loan to consolidate and pay off your debts, our debt consolidation calculator can help you determine if this approach may be right for you.

3. Covering expensive unexpected bills.

Life can sometimes throw us curveballs, and costly medical bills are all-too-common examples. These unplanned expenses can wreak havoc on your budget, especially if you haven’t built up a significant emergency savings fund. A home equity loan could provide a financial safety net in these situations.

Let’s say you face a major medical procedure not fully covered by insurance. A home equity loan can foot the bill, potentially at a lower interest rate than other borrowing options. This can give you more breathing room to manage your medical costs without derailing your long-term financial goals.

Of course, using a home equity loan to cover unexpected expenses comes with the same responsibility as using it for renovations or consolidation. Timely payments are crucial to avoid jeopardizing your homeownership. Consider this option for short-term, emergency needs, and have a plan to replenish the funds borrowed from your home’s equity. 

What’s not a good use of a home equity loan?

A home equity loan unlocks the value stored in your home, but with great power comes great responsibility! Because your house itself is on the line as collateral, it’s important to use these loans strategically. 

Let’s review some situations where a home equity loan might not be the best option.

1. Buying a car. 

An auto loan is usually a better choice than a home equity loan when purchasing a new or used vehicle. Interest rates on auto loans tend to be similar or lower than those on home equity loans. And, auto loans usually require little paperwork and fewer fees.

2. Paying for a vacation. 

It’s far better to save for near-term wants such as vacations or a large-screen TV than to use your home’s equity for something that offers no financial return. Consider setting aside money in a high-yield savings account specifically for vacations or other planned expenses. This way, you’ll have the funds you need without putting your home up for collateral. 

For bigger trips, explore rewards credit cards that offer travel points or miles, or consider a personal loan with a fixed repayment term.

3. Funding a college education.

A home equity loan may be a consideration if current mortgage rates are significantly lower than federal student loan rates, especially for graduate or professional degrees. A line of credit may also be useful for parents whose children are a few years apart. That way, they can use the money for tuition and pay down the balance in time for the next child to enter college.

That said, unlike federal student loans, if you use home equity to pay for college, you won’t qualify for income-driven repayment plans or loan forgiveness programs. Consider all your options—including federal student loans, scholarships, grants and private student loans—before tapping into your home equity. 

4. Starting your own business.

Although you could access your home’s equity for this purpose, you’d literally be putting your home on the line. Your best bet for getting the funds you need to launch your new small business is to take out a business loan through a financial institution or the U.S. Small Business Administration (SBA).

5. Covering recurring or everyday expenses.

Tapping into your home equity to cover everyday bills can be a slippery slope. This can seem like a quick fix, but you need to think about your long-term ability to repay the loan. 

Since your home would be on the line as collateral, missed payments could lead to foreclosure. If you’re struggling to make ends meet, a home equity loan might not be the best answer. In these situations, try exploring alternative options such as credit cards (used responsibly, of course) or a personal loan with a fixed repayment term. 

The Pros and Cons of Home Equity Loans and Lines of Credit

There are situations where using your home’s equity can be a smart decision, such as when you’re investing in a valuable home improvement or consolidating debt to save money over time. On the other hand, short-term financial needs may be served better through other options, such as taking out an auto loan or stashing more in a savings account.

Here’s a quick recap of the pros and cons of home equity loans and HELOCs compared with other lending products:

If, after considering the pros and cons, a home equity loan or HELOC seems like a good fit for your financial goals, the next step is to prepare for the application process. 

Tap into your home’s equity with help from us.

If you’re considering using your home’s equity to accomplish one of your goals, visit Navy Federal Credit Union's Home Equity Loans page or give us a call at 1-877-573-2324, extension 2, weekdays from 8 am to 6 pm ET. We’re here to help you use what you have to get what you want.