Key takeaways
- Home equity is the appraised value of your property minus the amount of your outstanding mortgage balance — essentially, 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.
Homeowners have gained heaps of equity in the last several years, rising by $806 billion (or $13,900 per homeowner) alone from the first to second quarters of 2023, according to 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.
What is home equity?
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 paid upfront as opposed to the amount you financed. You build more equity by making mortgage payments, as well as over time as your home’s value appreciates, whether due to market conditions or by upgrading your home (or a combination).
$13,900
The average amount of home equity gained by U.S. homeowners in Q2 2023.
Source: CoreLogic
How to calculate the equity you have in your home
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 of what’s available. 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 percent. An LTV ratio of 60 percent means you have 40 percent equity in your home.
How to take equity out of your home
There are three common ways to convert your equity into cash:
Home equity loan
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, so they typically come with a slightly higher interest rate than first mortgages. The difference is due to the lender’s lien position: In the event you default on the loan and your home is foreclosed, the home equity lender has a claim to the proceeds of the sale of the home — but only after the primary mortgage lender recoups its money.
Pros
- 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, for example
Cons
- 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
HELOC
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.
Pros
- 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
Cons
- 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
Cash-out refinance
A cash-out refinance allows you refinance your current mortgage for more than the outstanding balance and take 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.
Pros
- Good if you were thinking of swapping out your mortgage anyway (if mortgage rates have fallen, for instance)
- Good if you prefer to have one big loan, rather than two
Cons
- 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
Learn more: Cash-out refi vs. home equity loan: What you need to know
How to choose the best home equity method for you
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, 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.
How much equity can you take out of your home?
It depends on how much equity you have and your lender. Regardless, though, you can’t take out the full amount of equity — so if you have $100,000 in equity, say, you can’t simply access $100,000. Most lenders allow you to borrow 80 percent to 85 percent of your home’s appraised value. If you have $100,000 in equity, you likely won’t be able to access more than $80,000 to $85,000.
Benefits of taking equity out of your house
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 with 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.
Risks of taking equity out of your house
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 used as collateral for 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, 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 amid a downturn 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.
Other considerations when getting a home equity loan
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 what 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.
Next steps
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 only take equity out of your home for 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 with a few lenders to get a sense of your options. Check out Bankrate’s reviews of home equity lenders as you compare.
FAQ about taking out home equity
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 often depends on what you are doing with it. Some people use home equity loans to consolidate unsecured, high-interest debt and drop overall payments. Others use equity for remodeling or home improvement projects. These kinds of goals usually come with set budgets that make it easy to anticipate the amount you want to borrow. This allows you to determine whether or not you can afford the additional monthly obligation of paying off the loan. “If customers have a need for cash or liquidity, taking equity from your home is often the cheapest form of financing available,” says Gupta. “If customers have other sources of cash or liquidity available such as cash, 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.”
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.
