How to use home equity
Cash in on your homeownership
If you’ve lived in your home for over five years, there is a good chance you have a decent amount of equity built up. Home equity is the value of your home that you truly own — the amount you get when you subtract the outstanding balance on your mortgage from your home’s value.
Home equity can be considered an asset and used as collateral for loans. Homeowners can tap into their equity through options like a home equity loan or a cash-out refinance for purposes such as renovations or debt consolidation.
Key insights
- Most lenders allow you to borrow up to 85% of your home’s equity.
- Borrowing against home equity can be advantageous for some but financially disastrous for others.
- It’s typical to access equity through a home equity line of credit, home equity loan, reverse mortgage or cash-out refinance.
How to access your home equity
There are a few ways to get equity out of your home, including a cash-out refinance, a home equity loan, a home equity line of credit (HELOC) or a reverse mortgage. You may qualify for some or all of these options, depending on your situation.
- Home equity loan
- A home equity loan is a type of second mortgage, meaning it uses your home as collateral but doesn’t replace your primary mortgage. You get a lump sum of cash upfront and are required to repay it back in fixed monthly payments. If you fail to pay back the loan, you risk foreclosure.
- Home equity line of credit (HELOC)
- A HELOC lets you borrow up to a specific amount of cash as needed. It’s a line of credit, like a credit card, with a set limit and variable interest rate. It is another type of second mortgage.
The benefit of a HELOC over a home equity loan is that you’re able to take out only the funds you need at the moment, which can reduce the risk of overborrowing. If you have an ongoing project and aren’t sure how much it will cost in the long run or you’ll need consistent access to cash, this could be the right option for you.
- Cash-out refinance
- Cash-out refinancing replaces your old mortgage with a new loan for a higher amount than what you currently owe and gives you the difference in cash. As with other loan types, you’re responsible for paying back the new loan under the newly refinanced rate and terms.
- Reverse mortgage
- A reverse mortgage is a home equity product specifically for older homeowners — usually those 62 and older. Reverse mortgage lenders allow seniors to borrow against the value of their home and receive the funds in a lump sum, monthly installments or as a line of credit.
When you get a reverse mortgage, you don’t make payments back to the lender monthly; instead, repayment happens when the borrower dies, sells the home or moves out permanently.
What can you use home equity for?
Home equity can be used for a variety of purposes, but just because you have equity in your home doesn’t mean it’s “free money.” You will still need to pay back what you borrow with interest.
Here are some common uses of home equity funds:
Home renovations
Making renovations is one of the most common uses of home equity. Homeowners often go this route for home improvement projects for a few reasons:
- Renovating increases property value
- Interest on a home equity loan may be tax deductible
- Rates may be lower than on other types of loans
Pay off debt
Many homeowners tap into their equity to consolidate debt or to pay off big expenses — like wedding, business or college debt. In some cases, this makes financial sense. In others, it just creates more debt down the road.
Josh Richner of the National Legal Center, a consumer rights law firm focused on helping people get out of debt, offers three reasons you might consider a home equity loan to get out from under past debts:
- You’re confident you can repay the new debt. Never swap one debt out for another without first considering the implications. If your new debt on your home equity loan is more affordable than your old one, it may be a good move.
- The interest rates make sense. Mortgage rates are often much lower than credit card rates, but they may not be lower than student loan or traditional loan rates.
- You can afford the payments. Taking out a loan isn’t always a bad idea, especially for something like college or a wedding. Just make sure you can afford the payments for the entirety of the loan term.
Emergency expenses
Tapping into your home equity can help out in an expensive emergency, especially when considering how costly other quick alternatives, like payday loans, can be. However, if you don’t have a realistic plan to repay the debt, this option could be risky.
Educational expenses
Some homeowners use their home equity to cover educational expenses, such as tuition fees, for themselves or their children. This can be a more affordable financing option compared with student loans or other types of borrowing.
When not to use your home equity
Just because you can access your home equity doesn’t mean you should. Some people think of their home equity almost like a piggy bank, but it’s important to remember that by tapping into your equity, you’re putting your home on the line, said Richner.
Here are a few questions to ask yourself before using home equity:
- Can I afford to lose my home? There are other ways to fund certain needs, like a vacation or college tuition, without the risk of losing or going underwater on your home.
- What are the housing trends? If real estate values decrease in your area, you could end up owing more than your home is worth when it comes time to sell.
- Will my loan payments really save me money? Sometimes it’s cheaper to pay each debt separately rather than consolidate and use your home equity to pay them off. Home equity loans may have cheaper rates, but the terms may be longer and end up costing you more in the long run.
How to calculate home equity
You can determine your home equity by subtracting the principal amount owed on your mortgage from the current market value of your home. To get the current market value, most lenders will require an official appraisal during the approval process.
If you’re curious about what your equity is, you can search your address on a real estate website for an estimated value.
For example, Lisa’s home is worth $450,000, according to a recent appraisal, and her outstanding loan balance is $100,000. So, she has $350,000 in equity.
Lenders use what’s called the loan-to-value (LTV) ratio to determine your eligibility for a loan. Most require an LTV ratio of 85% or lower. To calculate your LTV ratio, divide the loan balance by the appraised value and multiply by 100.
In Lisa's case, since her home is valued at $450,000 and her balance is $100,000, her LTV ratio is 22%.
FAQ
What are the advantages of using home equity compared to other types of loans?
Home equity loans typically have lower interest rates and higher borrowing limits compared to personal loans or credit cards. In the past, the interest paid on a home equity loan or line of credit was tax deductible if used for renovations. Currently, this is not a tax benefit, but it might be after 2025.
What are the risks of using home equity?
Borrowing against your home equity also adds debt and interest payments, which could strain your finances. One significant risk is that your home serves as collateral for the loan, which means if you're unable to repay the loan, you could potentially lose your home.
How much equity should I have in my home before selling?
It depends on why you’re selling your home. There’s no real set-in-stone guideline, but, in general, the more equity you have built up, the better. You can use the equity toward the down payment for your next home, reducing your principal and increasing equity in your new property.
Bottom line
According to Alan Harder, a mortgage broker in Vancouver, British Columbia, it's important to compare offers from multiple lenders to ensure you get the best deal before you tap into your home equity.
“If you're strategic about how you use a home equity loan, it can be a valuable tool in building your financial future,” he said.
If you’re unsure which home equity option is right for you, a financial advisor can help you make an informed decision so you can avoid jeopardizing your finances.
- Article sources
- ConsumerAffairs writers primarily rely on government data, industry experts and original research from other reputable publications to inform their work. Specific sources for this article include:
- Consumer Financial Protection Bureau, “What is a home equity loan?” Accessed August 3, 2022. Federal Trade Commission,
- “Home Equity Loans and Home Equity Lines of Credit.” Accessed August 3, 2022.
- U.S. Department of Health and Human Services, Administration for Community Living, “Reverse Mortgages.” Accessed August 3, 2022.
- IRS, "Is interest on a home equity line of credit deductible as a second mortgage?" Accessed June 17, 2023.
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