The expansion of prices in the housing market combined with record-low interest rates means that families across the country are growing their net worth simply by being homeowners. As of November 2021, housing prices have increased 18% year over year.¹

As you pay down your mortgage, your home is essentially acting as forced savings, growing your overall net worth. For many, your home is the largest asset on your balance sheet. But how can you tap those “savings” to build your overall wealth or even diversify your assets? Leveraging your home equity can provide access to funds at very low interest rates, which can reduce your debt or be used to finance another asset purchase. However, this strategy comes with unique risks as your home’s value can go down (remember 2009?).

Home equity loans let you borrow against the equity in your home.  We break down how home equity can be used as a wealth-building tool in the right situations.

Home Equity Loan vs Home Equity Line of Credit

First, lets breakdown two ways you access this value in your home.

Home equity loans generally allow you to borrow up to 80% of the home’s value. The homeowner can borrow a lump sum and then pay it back over time (commonly banks look for a 10-year loan). For example, if your home was worth $1mm, and you owed $500k on your primary mortgage, you could potentially take a Home Equity Loan of $300k.

A home equity line of credit (HELOC) is like a home equity loan in the sense that you’re adding an additional mortgage payment, but the main difference is that instead of getting all the borrowed cash up front, you can borrow as needed. Using the above example, if the $300k was a HELOC, you could pay it back in a year, and then borrow another $300k against the same HELOC. The risk with a HELOC, is that, unlike home equity loans, HELOCs often have adjustable interest rates (based on a preset time schedule, aka every year, or instead tied to a published rate like SOFR). These are less risky in falling interest rate environments, with rates poised to go up factoring in interest rate increases is important. However, since rates are still historically low, the advantages may outweigh a potential rate increase.

Another downside to the HELOC is there are usually additional closing costs.

Using Equity to Build Wealth

Home equity is typically used for larger purchases or expenses that have clear potential upside. You are putting your home up as collateral, so it’s crucial that the funds are being used responsibly to potentially create more value.

Tapping into home equity really comes down to one thing: Can you earn more with the borrowed funds, even if it is over time, than the cost of the loan? If so, using home equity can be an effective wealth-building tool. Here are three ways you could use these funds:

Paying off Debt

Paying off high-interest debt –– such as credit card debt or student loans –– is a great way to save money. One word of caution: While this can be an effective strategy, make sure you are not kicking the can down the road with an underlying spending issue. If you don’t live within your means, you are destined to eventually be back where you started and could be facing a foreclosure.

Paying off student loans, or even using home equity to fund an additional degree, can make sense. Depending on your loans, you may be locked into a higher interest rate with a very long repayment timeline. Paying off student loans can potentially save quite a bit of money long-term, even if it temporarily increases your monthly payment amount.

Buying a Rental Property

When my wife and I purchased our first home in 2004, we were able to take advantage of the large amount of equity that built up in it to help us purchase a second home in 2007 (which became my primary home). We then rented our original home which allowed us to pay off the mortgage and the new HELOC.

Starting a Business

Depending on your personal risk tolerance, you may consider using the funds from a HELOC to start a business. This does come with considerably more risk than the traditional use of consolidating debt. If you do choose this path, make sure you have a solid business plan, a limit on what you will borrow, and worse case exit strategy if things go wrong.

The Risks of Using Home Equity

While tapping into home equity can be a viable option to expand your wealth, it does come with risks. Remember, home prices don’t always go up, and can go down or sideways for a long period of time. In my own situation, I had just that happen as the housing markets crumbled in 2009. All the equity that was built up in our first home that we rented was eaten up when the housing bubble burst. Our significant gain was whittled down to breakeven in our first home, and our second home was eventually sold at a loss.

In addition to the housing market, don’t forget the interest rate risks. In a HELOC, the interest rates are variable which means the homeowner may end up paying more over the length of the loan than they expected.

The Takeaway

If thinking about using home equity, first determine how much makes sense for the situation. Have a plan for how the money will be used, understand the potential value created with the loan proceeds, and accurately gauge your ability to repay it.

If used appropriately, tapping into home equity can be an effective wealth-building strategy, but it does come with risks.

1. Economy Team. U.S. Home Price Insights. January 4, 2022. CoreLogic.
2. Internal Revenue Service. Home Mortgage Interest Deduction. March 1, 2021. IRS.

Lake Road Advisors, a Fee-Only, independent financial planning firm with offices in Corning, NY, Ithaca, NY and Portland, OR works with clients virtually all across the country. Paul Sydlansky, the founder of Lake Road Advisors LLC, has worked in the financial services industry for 20+ years. Prior to founding Lake Road Advisors, Paul worked at Morgan Stanley in Manhattan for 13 years. While at Morgan Stanley, Paul was a senior-level manager within the Institutional Equities Department. In 2018 he was named to Investopedia’s Top 100 Financial Advisors list. Paul received a Bachelor’s degree in Economics from Marist College and holds an MBA from New York University Leonard N. Stern School of Business. Paul is a CERTIFIED FINANCIAL PLANNER™ and a member of the National Association of Personal Financial Advisors (NAPFA) and the XY Planning Network (XYPN).