home equity

Know risks before tapping home equity

Don Taylorq_v2.gifDear Dr. Don,
I just read with interest the article titled "Don't use equity for home improvement." Yet the Q&A did not really come right out to say that home improvement is not a good way to use equity.

I'd like to know if you really do advise against using equity for home improvement. More importantly, why would you say that it is a bad idea? I have always been under the impression that using home equity for boats, vacations, new cars and other toys in general is the mantra for how not to use the equity in your home.
-- Doubting Deb

a_v2.gifDear Deb,
The advice I gave Michelle Mulch in the column "Don't use equity for home improvement" was specific to her situation. That's why it's called personal finance. I hope other people who read these columns can learn and make better decisions based on what they take away from reading them. However, in an individual column, I'm answering a reader's specific question about a financial problem.

Tapping your home's equity to improve your home -- and ideally improve your home's value -- can make perfect sense if you have enough equity and enough flexibility in your monthly income to cover the increased debt load. There can be some bad decisions here, too. Remodeling and renovation projects that return 60 cents on a dollar invested need to provide a lifestyle return as well to be worthwhile.

The Bankrate feature "Home improvements and house value" can provide some insight about these trade-offs.

I can make a decent argument for using a home equity loan to buy a car; in fact, I've done it myself. A low interest rate on a securitized loan with interest expense that is, for some taxpayers, tax deductible, isn't all bad. That said, it really works only for people who can effectively budget their monthly income by spending less than they make. It is not a good idea to raid a home's equity as a piggy bank.

As for the other ways to spend your home's equity, people have to make a trade-off between current consumption and future consumption. Often, it's a bad trade.

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