5 Smart & 5 Not-So-Smart Ways to Spend Your Home Equity
5 smart ways to use home equity
Debt Consolidation Loans
In Canada, debt consolidation is the most common use for home equity loans. Loans that are backed by residential equity carry significantly lower interest rates compared to other debt vehicles. This, in turn, allows homeowners to pay down their debt faster without increasing their monthly payments into an amount they can't afford.
Home Renovation Loans
Taking out money from your home in order to put it right back into it is a good way to spend your equity loan. It is very important, however, to carefully plan your renovations. Repairing your home often means finding other issues you didn't even know you had like a leaky roof. Be sure to account for this when asking for a loan amount. However, even after the renovation expense, a homeowner's loan-to-value ratio improves because the value of the property is higher now too.
Purchasing for Self-Employed
Ever-tighter lending restrictions passed down by OSFI have made it increasingly difficult for self-employed persons, who make up more than one-seventh of Canada's workforce, to get a loan. Home equity loans are an increasingly common way for self-employed individuals to buy a home in Canada.
Business Cash-Flow/Business Loan Payoff
Home equity loans are a smart way to finance a business investment, or pay back a business loan.
Paying Off Tax Money Due to CRA
Owe back taxes? Banks (A-lenders such as BMO) will not lend mortgage funds (for a new purchase or a re-finance) if the person applying for the funds owes back taxes, even if there is equity in your home to pay it back. So, a common use for home equity loans is to create a short term loan that basically pulls equity out of the home, pays off the back taxes, and then transfers the debt back to an A-lender.
5 NOT-SO-smart ways to use home equity
Buy a brand new car
Don't buy depreciating assets like cars with appreciating assets like your home. Think about it....if you default on an auto loan that is equity-financed, you would lose the car and potentially your home.
It's happened...more than you think. People have financed trips to a casino or Vegas with funds from their home equity loans. Hoping Lady Luck will smile on them, they are willing to risk their family home for a roll of the dice. If you want to gamble, buy a lottery ticket. At least that won't cost you your home.
Buying speculative investments
A friend or relative comes to you with an investment too good to be true. It probably is and leveraging the future of your home to "get rich quick" is not a sound decision. The risk/reward is usually not worth it. After all, the definition of "speculative" is: based on conjecture rather than knowledge.
Going on vacations
Nothing is worse than coming home exhausted from a great vacation and then having to start paying for it. Don't pay for vacations with equity loans. Save for the vacation and then there will be no post-vacation regret.
Paying for a special event or luxuries
These days, the average cost of a wedding is around $26,000. Don't foot the bill with a variable-interest loan that could potentially put your house at risk. Same thing for luxury items like expensive cars, clothing, and jewelry....it's just not worth it. Buy the car, jewelry and other items with cash so that if something unexpected happens, they will just take the assets and leave your home alone.
Make the right choices and that home equity will work for you!