Home equity is the appraised value of your property minus the amount of your outstanding mortgage balance -- the portion of your home that's 'paid for'.
It can be accessed in the form of a home equity loan, home equity line of credit or cash-out refinance.
Tapping these funds can give you access to cash, often at lower rates than personal loans or credit cards.
There are risks associated with taking equity out of your home: increasing your debt load, and your home being seized if you default.
Homeowners have gained heaps of equity in the last several years. The total value of their ownership stakes rose by $1.5 trillion in the first quarter of 2024, a gain of almost 10 percent compared to the same time a year ago, according to property data analyst CoreLogic. If you're looking to borrow money, tapping your home equity can be a lower-cost route than credit cards or other forms of financing. Here are the basics on taking equity out of your home, and how to do it.
Your home equity is the difference between the appraised value of your home and how much you still owe on your mortgage.
When you buy a home, you instantly have some equity in it: an amount comparable to the down payment you made, or the amount you put in upfront as opposed to the amount you financed. Then, over time, you build more equity by making mortgage payments, as well as your home's value appreciates, whether due to market conditions or by upgrading your home (or a combination).
$305,000
The average amount of home equity owned per average U.S. mortgage-holding homeowner in the first quarter of 2024.
Source:
CoreLogic
You can calculate the equity in your home by subtracting your outstanding mortgage balance from the appraised value of the property. For example, if your home appraises for $200,000 and you owe $120,000 on your loan, you have $80,000 of equity in your home.
Lenders impose a maximum amount you can borrow from your equity, often capped at 80 percent or 85 percent. They also assess your loan-to-value ratio (LTV), or how much you still owe on your mortgage in relation to your home's worth.
Calculating LTV ratio
To calculate your loan-to-value (LTV) ratio, take the amount of your existing mortgage and divide it by the appraised value of your home. Using the above example, you would divide your mortgage balance ($120,000) by your home's appraised value ($200,000) to find your LTV: 60%. An LTV ratio of 60% means you have 40% equity in your home.
There are three common ways to convert your equity into cash:
A home equity loan is for a fixed amount, at a fixed interest rate, repaid over a set period, often 20 years. It works in a similar manner to a mortgage in that the loan is secured by the equity in the home.
Home equity loans are second mortgages, and typically come with a higher interest rate than first mortgages (as of Aug. 21, the benchmark $30,000 loan costs an average 8.52 percent, vs. a 30-year fixed-rate mortgage's 6.52 percent, according to Bankrate's national survey of lenders). The difference is due to the lender's position in the pecking order for creditors: In the event you default on the loan and your home is foreclosed, the home equity lender has a claim to the proceeds of a home sale -- but only after the primary mortgage lender recoups its money.
Good for those who own a large portion of the home outright
Good for when you need a set, lump-sum amount of money, for a big remodeling project or to pay off credit-card debt
Not ideal for those whose home is already serving as collateral for a large outstanding mortgage
Not ideal if you want the money solely for non-essential discretionary expenses
To cover the cost of a single home renovation project or another big-ticket expense, or to pay off high-interest credit cards.
A home equity line of credit, or HELOC, has a revolving balance like a credit card -- you'll be approved for a set amount, but you don't have to borrow it all. You use what you need. HELOCs have an interest rate that varies with the prime rate, though some lenders allow you to convert a portion of your HELOC balance to a fixed rate.
HELOCs often come with two lending stages over 30 years. The first 10 years is the draw period, when the line of credit is open and you're typically only responsible for paying interest. After the draw period ends, you can no longer access the funds. You'll then have 20 years to pay back both the principal and interest.
Good if you want the freedom to withdraw funds on an as-needed basis
Good if you have a long-term obligation or don't know exactly how much you'll require
Not ideal if you don't want a variable interest rate or fluctuating payments
Not ideal for those who don't want to take on ongoing debt for a long time
To fund a long-term, multi-faceted home-improvement project, cover ongoing higher education costs or fund a new business venture.
Learn more:
HELOC vs home equity loan
A cash-out refinance allows you to refinance your current mortgage for more than the outstanding balance, taking the difference in cash. A cash-out refinance replaces your existing mortgage, so depending on market conditions, you might be able to get a lower rate or better terms with the new loan.
Good if you were thinking of swapping out your mortgage anyway
Good if you prefer to have one big loan, rather than two
Not ideal if you don't have a large amount of equity in your home
Not ideal if you won't qualify for a lower rate than you currently have
If you can get a lower interest rate or a comparable one to your current mortgage, and need cash for a single large expense.
Learn more:
Cash-out refi vs. home equity loan: What you need to know
The best home equity option depends largely on what you plan to do with the money. Consider the following scenarios:
Paying off debt: To pay off high-interest debt, whether it's on credit cards or other loans, it might be better to take out a home equity loan. That way, you can borrow the exact amount you need to cover those outstanding balances. In addition, you'd have fixed monthly payments at a fixed interest rate, which are easier to budget for.
College tuition: A HELOC might be the better option for tuition and other higher education expenses. You know these bills will occur with some regularity for at least a few years, so withdrawing the funds for them on an as-needed-basis could make more sense -- especially since you'll only accrue interest on the amount you actually borrow.
Home improvements: The best option for this scenario depends on the project and whether you know the exact amount of money you need. If it's a single item or project -- replacing the HVAC system or installing a swimming pool, for example -- consider getting a home equity loan or doing a cash-out refinance. However, if you're working on a multi-phase remodel that has ongoing costs and an indefinite timeline, like an entire addition, a HELOC could be better. That way, you can pay the contractors in installments and have reserves to draw on if the project goes over budget.
Basically, it depends on how much equity you have and your lender's criteria for borrowers. The lender will analyze your:
home's worth
credit score
credit history
income level/assets
DTI ratio/debts, particularly other home-secured loans
Regardless of your creditworthiness, you can't access the full amount of your equity stake. On paper, your equity may be worth $100,000, say, but your tappable equity -- the sum you can actually get -- will be significantly less. Most lenders allow you to borrow 80 percent to 85 percent of your home's appraised value, even if you own the entire place outright. If you have $100,000 in equity, you can't borrow $100,000, in other words -- $80,000 to $85,000 would be the max. A few lenders might let you have as much as $90,000.
Learn more: How much equity can I borrow from my home?
When you need to cover large expenses such as home renovations or college tuition, using home equity can be a less expensive way to obtain the funds.
Lower interest rates: One of the primary benefits of tapping home equity is that you can often access cash at far lower rates than those of personal loans or credit cards. "It's often the cheapest form of financing available for homeowners," says Vikram Gupta, executive vice president and head of home equity at PNC Bank. "Because the loan is secured by the house, lenders can offer it at a lower rate compared to other consumer lending products."
Greater flexibility: HELOCs and home equity loans have few restrictions -- you are free to use the funds as you wish.
Possible tax benefits: If you put funds from a home equity loan or line of credit into home improvement, the interest you pay might be tax-deductible. The deduction is generally allowable if you use the money to "buy, build or substantially improve" your home, according to the IRS. You must also itemize deductions on your tax return.
While taking equity out of your home does have advantages, it's not without risk:
Your home is collateral: The primary downside to taking out a home equity loan or HELOC is that your home is backing the debt. "What that means is that if you are unable to make the monthly repayments for a sustained period of time, there is a risk that the lender could foreclose on (repossess) your house," says Gupta.
Possible credit and borrowing consequences: If your home is foreclosed upon, your credit score could drop significantly. A foreclosure will remain on your credit report for seven years from the date of the first missed mortgage payment. Afterward, a lender might not allow you to borrow money for several years -- generally, borrowers must go through a waiting period before being able to qualify for a mortgage. You could even end up with a deficiency judgment, which is a court order allowing a lender to collect additional money from you. The lender could garnish your wages, put a lien on any other property you own or levy your bank accounts.
Market downturns: Another concern often associated with taking equity out of your home is the potential for a downturn in property values or a recession in the overall real estate market. "If home values in a given market are declining, borrowers run the risk of owing more than what the home is worth," says Jason Salcido, an assistant vice president at PenFed Credit Union.
If you think you're ready to use your home equity, keep the following in mind:
Home equity rates are relatively low: HELOC and home equity loan rates are often much lower than those for credit cards and other types of loans, and they might be easier to qualify for. This is because home equity loans are secured loans, meaning they are backed by collateral (your home, in this case).
Home values can fall: One reason to be careful with home equity loans is that home values fluctuate. If you take out a big loan and the value of your home drops, you could end up owing more than the amount your house is worth. This is known as being "upside-down" or "underwater." The housing crash of 2008 left millions of borrowers stuck in homes they could not sell because the value of their homes sank and their mortgage debt was more than their homes were worth.
Your house is on the line: If you bought your house or refinanced when rates were low, you have to ask yourself how wise it is to do a cash-out refinance, especially if the rate you'll be borrowing at is considerably higher than that of your existing mortgage. If you fall behind on payments, you're at risk of foreclosure.
If you're considering borrowing equity from your home, the next step is to approximate how much your home is worth. Then, take your existing mortgage balance and divide it by your home's value to figure out if you might be eligible for a home equity loan or refinance.
Then, develop a plan that addresses why you want to take equity out of your house, and how and when you'll pay it back. It's best if you have a specific purpose that has a positive financial payback. This could be anything from consolidating other debts with a lower interest rate to increasing your home's value through a major home improvement project.
Finally, whether you choose a HELOC, home equity loan or cash-out refinance, shop around to get a sense of your options. Bankrate's reviews of home equity lenders can help you compare.
Is it a good idea to take equity out of your home?Many homeowners have a sizable percentage of their total net worth tied up in their home. Whether or not you should take equity out of your home, exchanging an asset for debt, often depends on what you are doing with it -- and what your other financing options are. "If customers have a need for cash or liquidity, taking equity from your home is often the cheapest form of financing available," says PNC Bank's Vikram Gupta. "If customers have other sources of cash or liquidity available such as investments or other financial assets, they should weigh the returns they generate on those funds versus the cost of a home loan and make an appropriate risk-versus-return tradeoff."
What are ways to increase your home equity?There are a number of ways to build equity in your home beyond simply making your mortgage payments on time. The most effective, immediate way is to pay off your mortgage sooner, either in the form of larger or more payments than required. Renovations and remodels that enhance the home's market value also increase your equity stake, though it's a more roundabout method, and the exact appreciation is harder to measure.
Can I take the equity out of my current home to purchase a second home?Yes, you can use your home equity to buy a second home, but this approach comes with downsides. Unless it's adjoining your primary place (and so, arguably, an improvement to it), you probably won't be able to deduct the loan interest. Also, if you're planning to finance most of the purchase, be aware that some lenders don't allow you to use borrowed funds for a down payment.
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