4 Smartest Ways to Use a Home-Equity Loan

Building equity that you can tap into for a loan is often touted as one of the main benefits of owning a home. This loan can be used to pay for everything from major home improvements to a child's college education.

But the truth is that there are good ways and bad ways to use your home's equity. There's also a big risk in doing so: Home equity loans are secured by your home. If you default on your payments, your lender can, as a last resort, take your home. That can't happen with unsecured debt such as a personal loan or credit card debt. (See also: Home Equity Loan or HELOC: Which Is Right for You?)

How should you use a home-equity loan? These are some of the best ways.

1. Fund a major home improvement

Homeowners have long used home equity loans to fund big home improvements such as kitchen remodels or master suite additions. And they can be a smart use of your home equity dollars. Just don't expect a complete return on your investment if you plan on using these improvements to help sell your home.

While a newly renovated kitchen or updated master suite can make your home more attractive to potential buyers, and could help you sell your home faster, don't expect a dollar-for-dollar increase in your sales price. If you spent $15,000 on a new kitchen, that renovation likely won't boost your home's final sales price by $15,000. Buyers will still pay what your home is worth in today's market, no matter how much you improve it.

But if you are using your renovations either for your own enjoyment or to increase the number of buyers who will be interested in your home, using a home-equity loan makes sense. Remember, though, if you plan to sell your home before you pay off your loan or line of credit, you'll have to use the profits from your home sale to not only pay off your primary mortgage, but also your loan. That will eat into the money you take away from your sale.

2. Pay off high-interest credit card debt

Borrowing from your home equity comes with far lower interest rates than credit card debt. While credit card interest rates can reach 20 percent or more, home equity loans have rates that typically fall somewhere between 4 and 5 percent, depending on the terms. It makes financial sense to take out one of the lower-rate loans and use the money to pay off credit cards.

There are caveats, though. Credit card debt is unsecured debt. If you can't afford to make your monthly payments, you won't lose your home because of it. The same isn't true of home equity loans. If you can't afford your monthly payments with these loans, you could lose your home. So only take out a home-equity loan for credit card debt if you're absolutely sure you can afford the monthly payments.

Taking out a home-equity loan doesn't make sense, either, if your credit card debt isn't that high. If your credit card debt is manageable, instead of taking out a loan, pay a bit extra each month to reduce that debt over time. (See also: 5 Ways to Pay Off High Interest Credit Card Debt)

3. A child's college education

A home-equity loan can help you pay for a child's college education. And it might be a more attractive option for parents than taking out a private loan or a federal PLUS student loan that could come with high interest rates.

Be careful, though: You don't want to sacrifice your own retirement to fund your child's college education. If taking out a loan to help your children pay tuition will make it impossible for you to save enough for your own retirement, don't take out any loan, including a home-equity loan. Your children do have options for paying for college, from taking out their own student loans to attending more affordable universities.

Your priority should be to save for your retirement. If you're on track for this and can afford to help, a home-equity loan can be a smart way to do that. (See also: Are You Ruining Your Retirement by Spoiling Your Kids?)

4. Use it to invest

If you've always wanted to invest more in the stock market, a home-equity loan can help. Say you borrow money from your equity at an interest rate of 4.25 percent, and you use these dollars to invest. If your investment yields a conservative return of 8 percent, you'll have made a solid chunk of money.

Of course, there are risks. There is never any guarantee that your investment will increase in value, and you could even realize a loss. But if you are willing to take on this risk, and you can afford a possible loss, then investing home equity dollars into the market could make you wealthier.

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