Home improvements and debt consolidation are top uses
Fact checked by Timothy LiReviewed by Doretha ClemonFact checked by Timothy LiReviewed by Doretha Clemon
Homeowner equity increased by more than 9% from the first quarter of 2023 through the first quarter of 2024, according to CoreLogic’s Homeowner Equity Insights. The average amount of homeowner equity was greater than $300,000.
As housing prices vaulted, millions of Americans sought out home equity loans, by a process that involves taking out a loan—often at a lower interest rate than other forms of credit—that is secured by your house as collateral. Though there are some benefits to home equity loans, such as tax deductions under certain conditions, they also come with risks. If a homeowner defaults on their loan, they run the risk of losing their home entirely.
To prevent the risk seen in 2008, which required homeowners to maintain little to no equity in their homes, lenders require borrowers to maintain a 20% stake. Typically, loans are granted to homeowners with reasonable credit and two years of earnings history, among other requirements.
In many cases, people use home equity loans for renovations, such as remodeling a kitchen or bathroom. Other common ways that people use their home equity loan is for consolidating debt and retirement income.
Key Takeaways
- Home equity loans allow homeowners to take out a loan using their property as collateral. Different types of home equity loans include refinancing, second mortgages, and home equity lines of credit (HELOC).
- The value of U.S. home equity is greater than $300,000 as of the first quarter of 2024.
- According to a LendingTree survey of 2.3 million people who at least considered a home equity loan, the most commonly cited uses for the funds were home improvements, debt consolidation, non-home-improvement purposes, retirement income, or other purposes.
With data from a LendingTree survey of 2.3 million U.S. homeowners who at least considered a home equity loan in 2021, here are the top reasons, along with the top metropolitan areas, for each.
Home Improvements
Across 49% of homeowners, home improvements were the main reason. Additionally, it was the most cited reason across all 50 metropolitan areas. Among those areas, Boston and Philidelphia had the highest shares of participants. The average age of homes in Massachusetts is 54 years, older than any other state.
- No. 1: Boston (54.3%)
- No. 2: Philadelphia (53.0%)
- No. 3: Milwaukee (52.8%)
Within the U.S. tax code, the interest on a home equity loan used for home improvements is tax-deductible interest if the total mortgage debt is $750,000 or less for loans taken out on Dec. 16, 2017, and later. For loans taken out before then, the limit is $1 million. The Internal Revenue Service (IRS) states that the loan should “buy, build or substantially improve” the property.
Debt Consolidation
Debt consolidation was the second-most commonly cited reason, accounting for 24.0% of homeowners. As mentioned earlier, home equity loans often offer interest rates that are less burdensome than other credit types such as credit cards.
Las Vegas had the highest share of homeowners citing debt consolidation as a primary reason (at 31.8%), followed by Phoenix and Louisville, Kentucky.
- No. 1: Las Vegas (31.8%)
- No. 2: Phoenix (28.3%)
- No. 3: Louisville, Ky. (28.0%)
Though getting out of debt is a smart financial goal, it’s important to weigh the pros and cons of taking out a home equity loan to do so. Because home equity loans are secured, you run the risk of losing your home if things take a turn for the worse—a high price to pay for paying off other forms of debt.
Non-Home-Improvement Investment Purposes
Across 9.2% of homeowners, non-home-improvement purposes were the main use. Investing in a small business or investing in the stock market may fall into this category. Ranking the highest among metropolitans was San Jose, Calif., at 17.0% of homeowners.
- No. 1: San Jose, Calif. (17.0%)
- No. 2: Miami (14.0%)
- No. 3: Austin, Texas (13.1%)
Typically, the application process for a home equity loan is more straightforward than a small business loan, which often requires several years of tax returns and financial statements, which may be difficult for newer business applicants.
Retirement Income
Retirement income was the main reason among just 1.4% of homeowners. Las Vegas, Los Angeles, and Miami had the highest rates across all metropolitans.
- No. 1: Las Vegas (2.5%)
- No. 2: Los Angeles (2.2%)
- No. 3: Miami (2.1%)
In most cases, home equity loans have to be repaid within five to 30 years. Retirees may choose this purpose for a loan to help increase their retirement income thanks to many years of building equity in their homes.
Other
On average, 16.9% of homeowners’ uses for home equity loans fell under “other,” or they preferred not to disclose them. The California metropolitan areas of San Jose, Los Angeles, and San Francisco fell at the top for this reason.
- No. 1: San Jose, Calif. (24.1%)
- No. 2: Los Angeles (21.1%)
- No. 3: San Francisco (21.1%)
College tuition, buying a car, or boosting cash savings may fall under this category.
What Are the Common Uses of a Home Equity Loan?
Home improvement, debt consolidation, non-home-improvement investment purposes, and retirement income are the most common ways people plan to use their home equity loans, based on a report from LendingTree that surveyed 2.3 million people offered a home equity loan.
Can Home Equity Loans Only Be Used For Home Improvements?
The benefit of home equity loans and home equity lines of credit (HELOC) is that they can be used for any purpose, including paying for college tuition or paying off credit card debt.
It’s worth noting that home equity loans or HELOCs taken out for the purpose of home improvements have tax advantages. For mortgage debt under $750,000 (or $1 million if the mortgage began prior to Dec. 16, 2017), the interest on the home equity loan is tax-deductible interest if it is used to “buy, build or substantially improve” the property, according to the Internal Revenue Service.
What Are the Advantages of Home Equity Loans?
One main benefit of home equity loans is that they often offer lower rates of interest than other forms of credit, such as credit cards. In addition, interest on home equity loans used for the purpose of home improvement is tax-deductible interest.
What Are the Disadvantages of Home Equity Loans?
Like any form of credit, home equity loans and HELOCs carry disadvantages. The main risks to consider are that defaulting on the loan risks losing your home, variable interest rates may rise over the duration of the loan, a lengthy application process, and set repayment periods.
Can I Pull Equity Out of My House to Buy Another House?
It is possible to take out equity from a residence to purchase a second home. It’s worth noting that there are some disadvantages. The first drawback is that the interest on home equity loans can be greater than it is for a mortgage. In addition, home equity loans involve closing costs, which can make up as much as 2% to 5% of the loan value. Because your first home is used as collateral on the loan, any financial duress may cause you to lose your primary residence should you default.
The Bottom Line
There are many ways that homeowners use home equity loans. Thanks to the tax advantages and potential added value to the house, the majority of homeowners use home equity loans for home renovations.
Before taking out a home equity loan, it is important to consider the benefits and costs. This is especially true in a rising interest rate environment, which puts increased pressure on variable mortgage rates, credit card interest, and other forms of debt. Home equity loans provide access to a lump sum of credit with a fairly straightforward application process, but considering other options first may be wise before putting your home on the line.
Read the original article on Investopedia.