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Home-equity loans: the good, the bad and the risky

Our homes are usually our biggest investments.

They also are likely one of the biggest and best sources of loans for projects ranging from fixing up our properties to buying a car to obtaining funds for life needs, such as retirement.

The equity in our homes is valuable. And in this environment of low interest rates, a loan secured by home equity is a relatively easy, safe and effective way to free up funds for needed or desired spending.

In addition to the current environment of low interest rates, home-equity loans have an additional attraction: they may be tax deductible for some borrowers. Check with your tax adviser to be sure. But these days, there are not a lot of tax advantages with other types of borrowing. Loans secured by one's home remain, with some exceptions, one of the few tax-advantaged options.

So why take out a home-equity loan? Here are some scenarios that might make considering doing so worth your time:

Improving your home: This is the classic home-equity loan. The homeowner borrows against equity to free up cash to make that same home a more valuable property. Think kitchen or bathroom remodeling, or building an addition.

These kinds of loans are popular because they enhance the value of the property that is the underlying security for the loan. When and if the homeowner goes to sell, the home improvement may make the property more valuable. Even if you're not looking to sell, a home-equity loan enhances your enjoyment of the place you call home. Fixing up also can be cheaper and less stressful than buying new.

Buying another long-term asset: Tapping the equity in your home to buy something else can make a lot of sense. It also can be dangerous. One of the rules of thumb we like to use at our bank is reserving long-term borrowing for long-term assets.

So it could make sense to use a home-equity loan to buy a car, a business property or a new furnace. But borrowing against your home to take a family vacation generally is not a good idea.

Check the rates and talk with your local community banker. Other borrowing options may make more sense. But it's a good idea to ask how a home-equity loan might be an option if you are considering purchasing a long-term asset.

Freeing up cash for life needs: Having urged caution above, a home-equity loan still might be a better option than, say, a reverse mortgage for freeing up cash for life needs, such as spending in retirement.

Reverse mortgage loans may be an option, too, when considering borrowing for life's needs. But you will want to review the long-term costs associated with a reverse mortgage. A conversation about a reverse mortgage with your banker, accountant and financial adviser is always a good idea.

If you are considering a reverse mortgage to provide funds later in life, also think about tapping the equity in your home in a more traditional way through a home-equity loan. It's another idea to put on the table as you consider your options.

Our homes are where we live and we want to be careful to protect our ownership. But many of us would be wise to consider a careful tapping of the equity in our homes when we seek funds to purchase needed items or accomplish life goals.

Keep a home-equity loan in mind as a possibility and ask your community banker for advice about whether this tool could be an option for you.

Steven Raj is vice president of lending at Park State Bank in Duluth. You can reach him at stevenr@parkstatebank.com or (218) 727-8001.

Do you have a question about banking, personal finance or small business finance that you would like answered? Please email Dale Lewis, Park State Bank president, at lewisds@parkstatebank.com or call (218) 722-3500. We'd like to hear what topics would interest you in the Budgeteer's monthly banking column.

Steven Raj

Steven Raj is vice president of lending at Park State Bank in Duluth. You can reach him at stevenr@parkstatebank.com or (218) 727-8001.

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