3 ways to access your home equity

Your home is one of your biggest assets, and leveraging the equity you’ve built up doesn’t have to be difficult. You can convert the funds into the cash needed to achieve a major life goal or cover a large expense. Home equity loans, home equity lines of credit (HELOCs), and cash-out refinances are the most common ways to tap into your home equity. But before applying, it’s worth understanding how home equity works so you know which of these three is the best fit.

In a nutshell, home equity is a term used to describe the amount of your home you own outright. For example, if you make a 10% down payment when you buy a house, you immediately have 10% home equity, because you only have to take out a mortgage for the remaining 90%.

Your home equity generally increases as you make monthly mortgage payments or as the value of your house increases.

Calculate your home equity by deducting your outstanding mortgage balance from the market value of your home. If you have any other loans secured against your home, be sure to factor those balances into the equation.

For example, assume your home is currently worth $425,000, and you still owe $249,000 on your original mortgage. You also have a second mortgage of $43,000 against the home. In this case, your home equity would be:

$425,000 – $225,000 – $43,000 = $157,000

You have $157,000 in home equity, meaning you own almost 37% of your house. Assuming you meet the lending guidelines, you’ll be able to borrow a percentage of this amount.

Now, let’s dive into the three ways you can pull equity from your home.

A home equity loan is a popular option that lets you convert between 75% and 85% of your home’s equity into cash. It is a second mortgage, which means your home serves as collateral for the loan. This also means you’ll have two monthly mortgage payments, one for your original mortgage loan and one for your home equity loan.

If your application is approved, the home equity loan lender disburses the loan proceeds in a lump sum. The amount you receive is payable over time in equal monthly installments, making the balance more manageable as you’ll know what to expect. Terms typically last up to 30 years.

Here’s an example: Let’s say your home is worth $325,000, and you owe $175,000 on your current mortgage.

You could potentially access between $68,750 [($325,000 x 0.75) – $175,000] and $101,250 [($325,000 x 0.85) – $175,000] with a home equity loan.

• Fixed interest rate results in predictable monthly payments

• Predictable monthly loan payments make it easier to budget in the long term

• Loan terms of up to 30 years

• Closing costs are roughly 2% to 5% of your loan amount

• Risk of foreclosure if you default on your loan payments

• Market downturns could leave you owing more on your house than it’s worth

• You pay interest on the entire loan amount, regardless of whether you use the money

Home equity loans are ideal for homeowners who need money for a large, one-time expense. That’s because you’ll receive the money in a lump sum rather than in stages, like with a HELOC (more on that below).

They’re also good if you have a low interest rate on your original mortgage, and you don’t want to give that up by refinancing. When you take out a second mortgage, you get to keep the terms on your first mortgage.

A home equity line of credit also acts as a second mortgage, typically giving you access to up to 85% of the equity you have in your home. However, instead of receiving the funds in a lump sum, you are given a revolving line of credit that operates similarly to a credit card.

You can withdraw funds as often as needed, up to the credit limit, during what’s referred to as the “draw period.” On a 30-year HELOC, the draw period usually lasts for 10 years. As you repay what you borrow, the line is replenished and remains available for use until the end of the draw period.

The remaining balance is then payable over a 10- to 20-year period, depending on the HELOC lender. It’s common to make interest-only payments during the draw period, then payments toward both interest and the principal during the repayment period.

• Flexible withdrawal and repayment terms compared to home equity loans

• Only pay interest on what you borrow

• Interest-only payments are permitted by some lenders during the draw period

• HELOCs often charge variable interest rates, so your payments will fluctuate

• Closing costs are between 2% and 5% of the amount borrowed

• You risk foreclosure if you can’t keep up with payments

HELOCs are ideal if you need to cover several large expenses over time. For example, maybe you’re renovating your home in stages and aren’t positive how much money you’ll need over time.

HELOCs are also good if you want to hold on to your super-low rate on your first mortgage, because you don’t have to replace your original mortgage as you would if you refinanced.

A cash-out refinance is another way to tap into your home equity. However, it requires you to replace your current mortgage with a larger, new one that has different terms.

Most cash-out refinance lenders cap your borrowing power at 80% of the home’s value. So, if your home has a fair market value of $345,000 and you owe $195,000, you could potentially access up to $81,000 [($345,000 x 0.80) – $195,000] in cash.

With a cash-out refi, the lender pays off your existing mortgage and disburses the amount you pull out shortly after the loan closes. You’d then start paying on the new mortgage of $276,000, which equals the amount you already owed, plus the equity you converted into cash ($195,000 + $81,000 = $276,000).

• Potentially get a lower mortgage rate on your new mortgage

• One monthly mortgage payment as opposed to home equity loans and lines of credit, which add a second monthly payment

• Up to 100% of home equity is accessible through VA loan cash-out refinances

• If you already have a low mortgage rate, you would lose it by replacing your home loan with a new one

• Closing costs between 2% and 6% of the new loan amount

• Larger monthly payments could become a financial burden

• You risk losing your home to foreclosure if you can’t make your monthly mortgage payments

A cash-out refinance can be worthwhile if you can secure better terms on your new mortgage than on your original one. For example, maybe you bought in the last couple of years and have an interest rate over 7%. You could replace that mortgage with one that charges a lower rate.

There are three primary ways to access your home equity. You can take out a home equity loan, home equity line of credit, or cash-out refinance. The best option for your financial situation depends on the amount of equity you’ve built up, your financial profile, and whether you’re looking to refinance your current home loan or take out a second mortgage. Shared equity agreements and reverse mortgages are also options, but they are less prevalent among homeowners.

Several circumstances may make borrowing against your home equity an ideal option. Common uses include debt consolidation for those struggling with high-interest credit card debt or covering the cost of home repairs or improvements. Others tap into home equity to build an emergency cushion or cover unexpected costs.

Some mortgage lenders allow you to pull equity from your home right away or shortly after closing on your original mortgage, assuming you have enough equity. However, you’ll pay closing costs with home equity products, so taking one out right away may put you in a financially difficult situation. You could find yourself underwater on your home loan should market conditions change.

The amount of equity you can take out of your home depends on the lender, your financial profile, and the type of mortgage you choose to access your home equity. That said, you can typically borrow up to 80% of your home equity.

Laura Grace Tarpley edited this article.