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Home Equity Basics
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Why people borrow against their equity

People borrow against their home's equity for myriad reasons. The two most common are to pay for home improvements and to consolidate debt. Other uses for equity money are: to pay tuition, medical expenses, living expenses during unemployment, and big-ticket purchases.

There's one thing to watch out for when using equity debt to pay for medical care, unemployment or big-ticket items. You are unilaterally disarming yourself in the battle against creditors should you eventually have to declare bankruptcy. In a Chapter 7 bankruptcy, you can walk away from unsecured debt, such as credit card balances. But if your house secures those debts, you are stuck with paying them. If you can't make the payments, you can lose the house to foreclosure, and you won't see a dime of the sale proceeds until all the creditors are paid. It might be better to tap other sources of money: savings, your 401(k) or individual retirement account, or stocks and bonds.

Ways to use equity loans and credit lines
  • Home improvements: Making upgrades and repairs to a house can make the home safer, more energy efficient, more comfortable, better looking, or a combination of those things. It can increase your home's value.

    This is an efficient use of equity debt -- deploying it in such a way as to make the house more valuable. If you want to spend equity money to prepare the house for sale, make sure you apply for the loan before putting the home on the market. After you officially put your house up for sale, you will have trouble finding a lender willing to extend the loan.

  • Debt consolidation: Many people rack up a lot of credit card debt and turn to home equity to ease the burden by using their equity to consolidate debt. Doing this can reduce monthly interest charges, because credit card interest rates are often more than 10 percentage points higher than rates on home equity loans and credit lines.

    There's a dark side to using equity to consolidate other debts. You might be tempted to run up the credit card balances again, leaving you with big debt and no equity. It might be best to cut up all but one or two cards, stop carrying them with you, and use cash more often.

  • Misc. (For education and medical expenses, unemployment and big ticket purchases): Sometimes, the easiest way to pay tuition and fees for the kids' private school, or for college or technical school, is to turn to home equity. This is especially true for families whose incomes are too high to qualify for grants or student loans. There are also student loans for this purpose.

    An equity loan can be a godsend if you are hit with thousands of dollars in medical bills or you lose your job. Tax advantages and lower interest rates also make equity loans an option when financing a car, motorcycle or some other high-priced purchase. Many a homeowner even uses equity in the primary home to make a down payment (or the entire purchase price) on a vacation home.

 

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Too soon for home equity loan?

Dear Dr. Don, I was wondering if it is possible to take out a second mortgage on my house to pay for my student loans. I've owned my house for about one year now, but I don't have much equity in the home. My student loan... Read more

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