7 ways you can use a home equity loan to build wealth (2024)

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• Home equity loans come with fixed interest rates, monthly payments, and repayment timeline.
• You can often qualify for a lower APR than you could get with a different type of loan or credit card.
• You can use them for paying off credit card bills, consolidating debt, and making home improvements.
• See Insider's list of the best HELOC lenders.

If you need to take out a loan, you'll want to get the best deal possible. This means choosing loan options that come with low fees and competitive interest rates, and making sure you're borrowing for reasons that will benefit you in the long run.

You may want to consider a home equity loan, also known as a second mortgage. This type of loan lets you borrow against the equity in your home, meaning it is secured by your property's value.

How do home equity loans work?

With a home equity loan, you use your home as collateral for a loan. You are usually able to get lower interest rates than you can get with credit cards and other unsecured loans. Home equity loans come with low fixed interest rates, a fixed repayment timeline, and fixed monthly payments.

Home equity loans won't work for everyone, since you need considerable equity to use them. Most home equity loans only let you borrow up to 80% of your home's value, minus what you still owe on your first mortgage. This means that, if you own a property worth $300,000, the maximum amount of equity you could borrow is $240,000 (300,000 x 0.8). If you still owe $200,000 on your mortgage, the most you can borrow with a home equity loan is $40,000 (240,000 - 200,000).

Also note that since a home equity loan offers your home as collateral, in a worst-case scenario where you couldn't repay the loan, the bank would be able to foreclose on your home.

That's why, if you're considering a home equity loan to fund your goals, it's best to take a step back before you do. Here are the best ways to use your home equity to your advantage.

1. Paying off credit card bills

The average credit card APR is now about 16%, so using a home equity loan to pay off high-interest credit card bills can be smart.

After all, some banks offer home equity loans with rates around 5%. If you transfer high-interest credit card bills to a home equity loan with a rate that's less than a third of what you're paying on your credit cards, you could save money and pay down debt faster.

Here's an example:

Imagine you have $10,000 in credit card debt at 17% APR. If you made a minimum payment of $300 each month, you would spend 46 months paying it off and fork over $3,629 in interest in the process.

If you transferred that debt to a home equity loan at 5.49%, on the other hand, things look totally different. With the same $300 monthly payment, you could pay off your debt in just 37 months and pay only $875 in interest.

2. Consolidating other debts

While credit card debt is one option for debt consolidation, don't forget you can use home equity to consolidate other types of debts. The key is choosing debts that have a higher interest rate than you could get with a home equity loan.

If you have a high-interest personal loan, auto loan, or private student loan and have a lot of equity in your home, for example, using your home equity could be smart. Consolidate all your debts with a home equity loan with low or no fees and a lower APR, and you could save big over the long haul.

3. Home improvements

Many consumers use home equity loans to make important home improvements or upgrades. You're using your home equity to improve your property, which should in turn boost the value of your house.

Per Remodeling Magazine, the top three improvements that net the highest return on investment are a garage door replacement (93.8% cost recouped), manufactured stone veneer (92.1%), and a minor kitchen remodel (72.2%).

Any kind of remodeling project can pay off if you personally find value in it. If you've always wanted a new kitchen and need to borrow to make it happen, a home equity loan is one of the most affordable ways to do it. Also note that if you qualify according to IRS rules, you can deduct the interest on home equity loans when the funds are used to "buy, build or substantially improve the taxpayer's home that secures the loan."

4. Home additions

Another way to use home equity to your advantage is by adding an addition to your home. Not only will the addition add value to your property by increasing your square footage, but scoring some extra room could help you prevent a pricey move as well.

If you love your home but simply need more space, adding a family room, bathroom, mudroom, or bedroom could help you score the square footage you need. A home equity loan can help you fund the project without tapping into your personal savings.

5. Down payment for an investment property

If you are angling to become a landlord or purchase commercial property, you can expect to fork over a big down payment. In lieu of tapping into your personal savings, you could use your home equity to get the cash you need. Since home equity loans are secured by the value in your property, they often offer the most competitive interest rate you'll qualify for.

6. Starting a business

You can also tap into home equity to start a business, whether that's opening a franchise or opening your own company from scratch. A home equity loan can help you access a large amount of money at once without tapping into your personal savings or taking out a pricey small business loan.

7. Emergencies

Finally, some people use home equity for emergencies. A home equity line of credit (HELOC) may be better for this purpose, though. Where home equity loans offer a fixed lump sum, fixed interest rate, and fixed monthly payment, HELOCs work as a line of credit you can borrow against. This makes them a lot like credit cards, although with much lower rates since any cash you borrow are secured by the equity in your home.

The best part about a HELOC is that, if you don't borrow any money, there's nothing to repay. That makes them useful for emergencies such as a job loss, unexpected medical bills, or a health scare. Just make sure to watch out for fees and compare HELOCs to find the best deal.

Ideally, you'd have an emergency fund in place to cover unexpected events. But if you don't have an emergency fund yet, a home equity loan or HELOC is a decent option.