How To Use Home Equity To Build Wealth

Having lived in several states, owning primary residences and investment properties, Josh Patoka uses his experience using mortgages and HELOCs to help first-time home buyers and home owners find the best home loan for their financial goals. His work has been featured on several financial and media websites.

Josh Patoka

Josh PatokaMortgages Writer

Mortgages Writer

Chris JenningsDeputy Editor, Loans & Mortgages

Chris Jennings is a writer and editor with more than seven years of experience in the personal finance and mortgage space. He enjoys simplifying complex mortgage topics for first-time homebuyers and homeowners alike. His work has been featured in a number of outlets, including Yahoo Finance, MSN, Fox Business, and GOBankingRates.

Reviewed

Chris Jennings

Chris JenningsDeputy Editor, Loans & Mortgages

Deputy Editor, Loans & Mortgages

Reviewed

Updated: Dec 14, 2023, 1:30pm

Editorial Note: We earn a commission from partner links on Forbes Advisor. Commissions do not affect our editors' opinions or evaluations.

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Home equity can be a valuable tool as you pursue your financial goals. By utilizing your home equity, you can borrow money with competitive rates and flexible repayment terms and avoid taking on higher-interest debt, like personal loans or credit cards. This financing strategy can also be a good option when you plan on living in your home for several years or longer.

What To Consider When Using Your Home Equity To Build Wealth

First and foremost, your home is a place to live and your retirement strategy may include selling your residence and downsizing. Until then, you can tap your home equity for important, big-ticket purchases and investments that can improve your finances. Home equity is the difference between the value of your home and how much you owe on your mortgage.

Your lending options include:

Depending on the lender and loan type, you can generally borrow up to 85% of the equity in your home. More equity becomes available as you pay down your mortgage and property values rise.

A home equity loan or HELOC can be convenient ways to tap your home equity as you don’t need to refinance your existing mortgage. Strictly borrowing against your equity and not doing a full refinance results in a smaller loan balance that keeps closing costs down. Some lenders may even waive certain closing costs and various fees on HELOCs and home equity loans entirely.

Here are the top advantages of borrowing against the equity in your home:

Competitive interest rates. Home equity loans generally have lower interest rates than other forms of financing, like unsecured personal loans or credit cards, as your home serves as collateral.
Long repayment periods. Your repayment period can be as long as 30 years, which reduces your monthly payment and allows you to have more disposable income for other financial priorities.
Potentially higher loan limits. Depending on your available equity balance, you might be able to borrow more than with other loan types.

How To Build Wealth With Your Home Equity

There are several ways to leverage your home equity to build wealth.

Make Home Improvements

The best home improvement projects increase your home’s value so you can command a higher selling price or borrow more equity in the future. If you plan on living in the home for the long term, you may want to utilize the money to make improvements that increase your quality of life and offer a good return on investment (ROI). For instance, painting the interior of your home or installing a new front door can see returns of 105% and 80%, respectively.

Home equity loan and HELOC interest payments can also be tax deductible when using the proceeds to buy, build or substantially improve the property securing the loan.

Pay Off Debt

Using a home equity loan for debt consolidation combines your debts into a single loan, often with a low interest rate. You’ll use the lump sum from the home equity loan to pay off your debt and then make monthly payments on the home equity loan until the loan is repaid.

Targeting high-interest debt, such as credit card balances, offers the most benefit as you can get a substantially lower interest rate with a home equity loan. For example, you can potentially reduce the debt’s annual percentage rate (APR) from 20% to 9%, saving you money and increasing your net worth.

Buy an Investment Property

You may decide to use your home equity to buy a rental property that can earn passive income. Once you’ve done your due diligence and feel confident that the investment property is worthwhile, your equity can help you make a cash offer and speed up the closing process, giving you an edge over other buyers.

One important thing to note: Investment property mortgages tend to have expensive closing costs, higher down payment requirements and a lengthy underwriting process that may not be an ideal option when you already have ample cash reserves and only need to borrow a small amount.

That said, it’s possible to use a home equity loan or HELOC to fund the down payment on an investment property—along with any major renovations—so that you don’t have to dig into those cash reserves.

Pro Tip

Some real estate investors also refinance their mortgage after completing the renovations and convert the increased equity into cash to put toward another rental property. This real estate strategy is known as the BRRRR method and is commonly used by real estate investors and house flippers to further increase their wealth.

Start a Business

Your home equity can serve as a pivotal lifeline when you start a business. It can help pay for your business startup expenses such as advertising, contractors, equipment purchases and office space. On top of that, the underwriting process for home equity loans may be more lenient than small business loans when you have minimal cash flow or time in business.

Become an Airbnb or Vrbo Host

You can use your funds to convert part of your house or a guest house into a short-term rental. While not every area allows short-term rentals, managing one can become a profitable income stream. To start, you could borrow money to add bedrooms, plumbing and kitchen amenities to an unfinished basement or a detached garage. Upgrading appliances and furnishings can increase the value of the rental too.

Short-term rentals can also be more lucrative than long-term rentals, especially in popular travel destinations, as you have the potential to charge and earn more per night. It’s possible to list your property on several vacation rental platforms. Airbnb and Vrbo are the most popular, though Vrbo only rents entire properties.

What Are the Downsides of Taking Equity Out of My Home?

There are several drawbacks that may cause you to refrain from borrowing against your home equity.

Fees and interest charges. Along with interest charges, many loans incur lender-related and third-party fees that increase your total borrowing costs. HELOCs, which tend to have variable rates, may hit you with interest rate increases.
May encourage overborrowing. It’s possible to borrow more than you need when you have plenty of available equity.
Potential foreclosure. Defaulting on a home equity loan or HELOC can result in foreclosure since your house serves as collateral.

As an alternative, you can try qualifying for a low-interest personal loan with a multiyear repayment period and the ability to use the loan proceeds for most personal or business expenses. Personal loans typically don’t require collateral, and secured personal loans can use a smaller asset, such as a car, as collateral to help you qualify for competitive rates.