Putting Your Home on the Line

Question of the week:I'd like to take out a home equity line of credit, but my wife hates the idea of going into more debt. What's your opinion about it?
--Tony C.

Dear Tony,

Plenty of people these days have the same idea. In fact, according to the Federal Reserve, homeowners' equity as a percentage of overall residential real estate value is now at an all-time low (about 56 percent), mostly due to the recent rush of mortgage refinancing and home equity loans and lines of credit.

But just because so many people are doing it doesn't automatically make it a good idea. When we asked Armchair Millionaire community members for their opinions, we heard arguments both for and against. Here are two examples:

No way. "A home is the best vehicle most Americans have for savings. By continuously extracting the equity in your home, you only perpetuate the attitude that cash is better than net worth." --Rick I.

Absolutely. "I always apply for one when I purchase a house as it can be done at the same time as the loan papers. I've used it for home improvements/repairs and bought my last car on it. When I sold the house, the car was also paid for, using cheap money!" --Jean

Home equity loans and lines of credit are popular for several very good reasons:

• They're usually tax deductible. Depending on your situation, the interest you pay on your line of credit may be deductible. (See your tax advisor).
• They have low interest rates. Because they are secured by your home, their interest rates are lower than for most other types of credit.
• They're fast and easy to get. You can typically obtain your line of credit in just a couple of weeks, and with low (or no) closing costs
• You can use them however you like. There are no restrictions on how you use the money. Make home improvements, vacation in the Caribbean, buy a boat--the choice is yours.

However, even though home equity loans and lines of credit can be used any way you choose, I still don't believe that they are right for every purpose. My guideline provides recommendations for when it's a good idea to tap your home's equity, and when it's not.

The Armchair Millionaire Guide to Using Your Home Equity

• Home improvements. I think this is the best possible use of home equity, because it puts the money right back into your house. Word of warning: Not all home improvements will result in an increase in your home's value. A kitchen or bath makeover probably will; new landscaping probably won't.

• Higher education. Home equity can be a great source of tuition funds if your child doesn't qualify for financial aid. Word of warning: If you're getting close to retirement and repaying the loan will severely impact retirement income, it's advisable to steer your child towards student loans, instead. The rates for student loans are often lower then those of home equity loans and lines of credit, and the interest may be tax deductible.

• To pay off debt with a higher interest rate. Paying down high-interest credit card debt with home equity can save you hundreds or even thousands in interest, as well as provide a nice tax break. Word of warning: Undertake this only if you have a concrete plan for changing your spending habits to stop incurring additional credit card debt. Otherwise, you'll just end up with more credit card debt and depleted home equity.

• Emergencies. A home equity line of credit is one alternative to an emergency fund of cold cash. (Remember that the time to arrange your line of credit is before you're faced with an emergency. If you've just lost your job, you may not get approved.) Word of warning: Having a line of credit is no excuse for not doing all you can to minimize the cost of emergencies--this means having the right kind of insurance, and enough of it.

• To pay for ordinary living expenses. This is an absolute no-no. If you feel you must use your home's equity to pay for day-to-day expenses, you need to re-evaluate your entire financial situation. Look at where you can cut spending or increase income, but don't risk losing your house in order to live beyond your means.

THE BOTTOM LINE: Your home is probably the biggest investment you have. Think very carefully before acting to deplete the value of that investment.