Can You Use Home Equity for Investments?

Want to invest by tapping home equity?

Is home equity investment a thing people do?

It is. Borrowers can tap their home equity and invest using that money. But is that something you should do?

We’ll get to that weighty question soon. However, let’s kick off with the basics.

What is home equity and how can it be used?

Home equity is the current market value of your home minus the balance remaining on your mortgage. After a period of sharply rising home prices, the average homeowner has a pile of this equity.

Indeed, during the fourth quarter of 2022, “U.S. homeowners on average still [had] about $270,000 in equity, nearly $90,000 more than they had at the onset of the pandemic,” according to CoreLogic.

Of course, some homeowners have much more than $270,000 and some have a lot less. How much you have will largely depend on how the property market in your area has been performing, how long you’ve owned the home, and the value of the property when you bought it.

We’ll describe the ways in which you can tap your home equity farther down the page. But they’re all “any-purpose loans.” That means the money’s yours to do with what you will once you get it. And many borrowers use it for one form of investment or another.

The pros and cons of home equity

Like anything else, leveraging your home equity has benefits and drawbacks.

Pros

• Because your loan is secured by your home, the interest rate and overall cost of borrowing you’ll have to pay is typically much lower than with unsecured loans and credit cards
• With home equity loans (HELs) and home equity lines of credit (HELOCs), you leave your main mortgage intact. That saves on both upfront closing costs and the higher mortgage rate than your current one that a refinance would usually bring
• Opt for a traditional installment loan (HEL) or a highly flexible HELOC
• Choose from a wide selection of loan terms. So, you can make high payments over a short period or low ones over a long period. You decide what’s affordable
• You also get to decide whether you want a fixed rate (most HELs) or a variable rate (most HELOCs)

Cons

• Both HELs and HELOCs are second mortgages. So, your home is on the line if you fall too far behind with payments
• The rate you’ll pay is likely to be higher than on a cash-out refinancing. But that’s probably a pro. (See the next section for why)

While the positives are powerful, it’s important to take seriously that your home is at risk if you fail to keep up with payments. Of course, that’s also true for your existing first mortgage. And you should only be worried if there is a real risk of your being unable to afford both loans.

How can you tap your home equity?

Traditionally, you have three mainstream ways to tap your home equity:

Home equity loan

With a home equity loan, you borrow a lump sum. And you repay that (plus interest) in equal monthly installments over the “term” (length) of the loan. Interest rates on these are almost always fixed.

Terms vary widely, commonly between five and 20 years, though 30-year loans are often available. So you can opt for a high monthly payment over 60 months or a much smaller one over 360 months. You’ll pay less overall if you borrow for a shorter time, so you want to choose the fewest monthly installments that you can comfortably afford.

Those equal installments and fixed interest rates make budgeting for your payments wholly predictable and easy. So, HELs are often seen as a safe and straightforward type of loan.

HELOCs

HELOCs are very different from HELs. In some ways, they’re like credit cards (but without the sky-high interest rates).

You are given a credit limit and can borrow, repay and borrow again as much and as often as you want up to that. And you pay interest — usually at a variable rate — only on your outstanding balance each month. This makes HELOCs great for those whose incomes vary greatly and for those who wish to borrow large sums for short periods.

But HELOCs are quite complicated. You get a “draw period” that might last up to 10 or 15 years during which you can borrow and repay at will. But then the “repayment period” kicks in, which often lasts between 10 and 20 years — you choose the length of both periods when you apply.

During the repayment period, you can’t borrow anymore. Instead, you must repay the closing balance on your draw period in equal installments over the remaining term. If you’re stuck, you may be able to refinance your HELOC.

Cash-out refinance

A cash-out refinance replaces your entire existing mortgage with a new, larger one. With cash-out refis, you receive the difference in value between your old and new loans in cash.

This is almost always a bad idea in a high interest rate environment since you’d refinance your whole mortgage into a higher rate.

Of course, when rates are relatively higher, you’ll also pay more for your HEL or HELOC. But the higher rate will apply only to your new borrowing, not your entire mortgage balance.

Building wealth through home equity investment

In some ways, your home equity is already invested. Your net worth increases every time it grows, either through home price increases or reducing your mortgage with each monthly payment. Tapping it messes with that steady and happy process.

It’s always a good idea to think twice before touching your home equity. A special anniversary party, a family wedding, a once-in-a-lifetime vacation … These are all very tempting and worthwhile but do you still want to be paying for them in 10, 20 or 30 years? Might you be better off saving up for them?

But it’s different if you’re accessing your equity in order to increase your wealth through investment. And we’re coming to that next.

Ways to invest through home equity

CNET Money suggests five good ways in which to invest home equity:

1. Home improvements — Repairs, renovations, remodelings and additions can all add value to your home, at least in the long term. And the interest on your HEL or HELOC is usually tax deductible for this purpose — but no others. However, check that with a tax professional before you borrow
2. Debt consolidation — If you have a lot of high-interest debt, you can pay it all off using your low-interest home equity borrowing. And that should leave you much more spare money at the end of each month. Just avoid the depressingly common practice of building up such debt again and finding yourself worse off
3. Alternative student loans — If you want to put a kid or kids through college, your home equity might answer your prayers. But check out alternative student financing first
4. Emergencies — You may be facing high unanticipated costs, such as medical bills. Or you may be uncomfortable because you lack an adequate emergency fund to cover future eventualities such as a period of unemployment. Given the high cost of most alternatives, you could see these as a home equity investment
5. Business expenses — Does your business need more funding to expand? Or are you starting up a new business and need seed funding? A home equity investment could be what you need. But be aware that “18% of small businesses fail within their first year, while 50% fail after five years and approximately 65% by their tenth year in business,” according to the Chamber of Commerce. So, be sure your enterprise (old or new) is investment-worthy

There’s another type of home equity investment that some find attractive. And that’s using a HEL to finance the purchase and renovation of an investment property for rental. But read our Guide to Becoming a Landlord before you take that step.

Are stocks a good home equity investment?

Some people argue that it’s a good idea to use home equity to buy stocks. But there are huge risks.

“Done in a diversified and careful way, borrowing to invest can be as valuable as investing in a home over the long term. To me, it’s about the individual and ensuring the strategy is the right thing for them,” said Tony Maiorino, head of the RBC Wealth Management Services team.

In particular, you need to have an appetite for risk that sees you through the vagaries of the stock market, which is much more volatile than the housing market. And you need to think long-term rather than be bothered by fleeting peaks and troughs. If you are cautious with your money, you may not enjoy the ride.

The bottom line

Most American homeowners have access to serious sums currently tied up in their home equity. Through a low-interest home equity loan or HELOC, they can use that money for any purpose.

Some choose to spend that cash on short-term pleasures. But many prefer to make a smart and responsible home equity investment, which could ultimately increase their net wealth.

And they might invest the money in home improvements, debt consolidation, higher education costs, emergencies, or business investments, including buying an investment property.