Smart uses for your home equity this holiday season

Should you tap home equity for holiday plans?

Americans are well aware that prices have skyrocketed, with inflation running at four-decade highs. No doubt that will add some financial stress to many families’ holiday plans.

The good news is that while prices have shot up, so have home values. And that’s led to record home equity gains, with the average U.S. homeowner sitting on nearly $300,000 in pent-up cash value.

Should you tap your home equity for holiday plans? Few financial advisers would recommend cashing out your home to pay for gifts, travel, or general holiday spending. But there are smart uses for home equity that can cushion your finances and potentially boost your cash flow this season.

When is it a good idea to pull equity from your home?

When you cash out equity from your home — whether using a cash-out refi, HELOC, or home equity loan — you can use the funds any way you choose. So, technically, you could use the money to buy presents for your family, finance a holiday vacation, or pay for a world-class party. But there are good reasons most financial experts advise against tapping home equity for this kind of spending.

• Loan terms are typically 10, 20, or even 30 years with home equity products. You could still be paying for your 2022 holiday spending in 2032, ‘42, or ‘52
• It’s always expensive to borrow over the long term, even with a very low interest rate. So those purchases will cost you a lot more in the long run
• Gifts, travel, and other such expenses typically don’t have a financial return on investment. Experts usually recommend spending equity where you’ll see returns, such as in home improvement projects
• Home equity products are second mortgages. So you’re putting your home on the line if things go wrong

Most people find those to be compelling reasons for not borrowing equity to fund short-term expenses. Again, lenders won’t restrict how you use the funds, so it’s up to you to decide what makes the most sense given your financial situation.

Best uses for your home equity this holiday season

Here’s the bright side. Although we’d caution against withdrawing equity to pay for holiday plans, there are other ways your real estate wealth can help you out this season.

If you’re looking to borrow equity during the holidays, you may be short on cash flow. If you use your home equity wisely, it could help free up your monthly finances so you have a little more cash on hand for your year-end spending. Here are just a few smart ways your equity could work in your favor.

Consolidate debt to lower your monthly costs

Home equity can be an excellent way to consolidate existing debts. Instead of making several high-interest payments on credit cards and personal loans each month, you simplify things with a single (usually much lower) payment on your home equity product.

It’s possible to consolidate debt with a cash-out refi or, if you don’t want to refinance your existing loan, with a HELOC or home equity loan instead.

Unfortunately, there’s an obvious danger. Some borrowers get into debt because they’re spending beyond their means. And after consolidating to a lower-cost loan, they run up their cards again and end up in the same situation — or worse, because they now have a new mortgage in addition to their other debts.

So don’t consolidate debts unless you have a clear budget in place to keep your finances healthy moving forward. Do that, and you could kick off the New Year with new confidence and a fresh feeling of tranquillity.

Start an emergency fund

If you’re already planning on dipping into your savings during the holidays, you might be worried about how that could impact your financial security. At the time this was written in October 2022, many economists were predicting a recession in 2023. And that could have scary implications for Americans’ financial outlook.

One thing that might protect you is a significant emergency fund: a sum you have saved for a rainy day. Way too few Americans have emergency funds at all while many others have inadequate ones. Indeed, in 2022, the Consumer Financial Protection Bureau reported that “Nearly a quarter of consumers (24 percent) have no savings set aside for emergencies, while 39 percent have less than a month of income saved for emergencies.”

A HELOC can be a great way to create an emergency fund. Once you open the credit line, it’s available for any needs that might arise. But if you decide not to use it, you won’t have any interest or debt to repay. So you can give yourself peace of mind without taking on a new debt payment right away.

Other projects

When times are good, many people use their equity for high-value home improvements and other projects that provide them with a financial return. If your existing debt levels are low and you already have an adequate emergency fund, you might still want to borrow for one of those.

Of course, it’s likely too late to start any improvement projects before your family comes to visit for the holidays. But you could get a head start on that home expansion or mother-in-law unit you’ve been wanting to build and have it ready to go when next year rolls around.

How to tap your home equity affordably

Home equity loans and HELOCs are typically among the cheapest forms of borrowing available. That’s because the debt is secured by your home and lenders can offer lower interest rates than on credit cards or personal loans.

Cash-out refinances typically have even lower rates than second mortgages. But they’re far less popular now that mortgage rates have increased. After all, who wants to refinance into a bigger loan with a higher rate, too?

Home equity lines of credit (HELOCs)

A HELOC often comes with low or zero closing costs. During the initial draw period, which is often 10 years, you can borrow, repay, and re-borrow as often as you like, and you pay interest only on your monthly balance. At the end of the draw period, you enter the repayment period. During that, you can’t borrow anymore, and you have to pay down your balance in equal installments with interest.

One downside is that HELOCs are almost all variable-rate loans. So if interest rates keep climbing, so will your payments.

Home equity loans

Home equity loans are usually fixed-rate installment loans. You borrow a lump sum and pay it back in equal installments over the term (length) of the loan. They couldn’t be easier, more predictable, or more straightforward. But they often come with closing costs that can total two to five percent of your loan amount.

You can learn more about the pros and cons of home equity loans vs. HELOCs here.

Your next steps

Whether you prefer a home equity loan or HELOC, your next step is to compare several lenders to find the best deal available to you. Shopping around can help you find the lowest interest rate and fees and save you serious money overall.

Once you’ve chosen a lender, they’ll show you exactly how much you can borrow and help you find the best loan option for your situation. Ready to get started?