How to get equity out of your home: Ways to tap home value

Home equity is a valuable asset that can grow as time passes. For example, someone who bought a house for $50,000 in 1980 may be able to sell the same house this year for $400,000.

That's quite a return on the investment.

Fortunately, homeowners don't have to sell the home to benefit from its equity. They can borrow money from the equity to improve the home, consolidate debt, or pay other big expenses. All the while, the home's value can continue to grow.

What is home equity?

Home equity is the paid-off part of a home's value. A home valued at $400,000 with $200,000 remaining on the mortgage has $200,000 in home equity. 

Making regular mortgage payments grows equity over time by reducing the mortgage's principal balance, decreasing the amount of the home value that's owned by the lender. Equity can also increase as home values increase or if the homeowner makes improvements or additions that add value. 

Owning home equity can create several financial advantages:  

• It generates profit when you sell your home, since you keep the equity after paying off your mortgage.
• It can secure lower cost loans like a home equity loan, cash-out refinance, or home equity line of credit (HELOC). 
• Money borrowed from equity can fund major expenses such as home renovations, education costs, or debt consolidation.

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When to consider tapping your home equity

Money borrowed from home equity usually charges lower interest rates compared to other types of borrowing, such as personal loans or credit cards.

But not every homeowner with equity wants to borrow from this asset. 

Here are some of the factors to think about before applying for a home equity loan or home equity line of credit (HELOC):

Market conditions to consider

• Interest rates: Home equity loans are mortgage products, so overall mortgage rates affect borrowing costs. When mortgage rates fall, rates on home equity loans and lines of credit tend to go down, too. 
• Area home values: Home appreciation creates more home equity. In times when homes appreciate more quickly, equity can grow faster. 
• Your home value: Even when area home values rise or fall, an individual home's value may behave differently. If a home is worth $400,000 one year and appreciates by 3% in the next year, it would then be worth $412,000, creating $12,000 more in equity.

Personal finance factors to consider

• Financial stability: If you have a dependable job and a healthy credit score, you may have access to lower rates on home equity borrowing. 
• **Manageable debt-to-income ratio **(DTI): You'll need enough room in your monthly budget to afford the new home equity loan payments.
• Emergency fund: Highly qualified borrowers keep a separate savings account beyond your housing equity in case of unexpected life expenses.

How to take equity out of your home: 3 ways

Most mortgage lenders offer three different ways to borrow home equity from a primary residence.

Each type of loan has its own strengths and weaknesses:

Home equity loan

A home equity loan works a lot like a personal loan. You receive a lump sum of money and then repay the money, at a fixed interest rate, by making regular monthly payments.

But a home equity loan typically offers better interest rates than personal loans because the home itself secures the debt. 

Home equity loans are also called second mortgages because they add a second mortgage payment to the home. The homeowner keeps paying the primary mortgage and adds a second payment for the home equity loan.

Home equity loan pros	Home equity loan cons
Fixed monthly payments provide predictability	Higher interest rates than cash-out refinancing
Keep your current mortgage and its rate intact	A second mortgage means two monthly payments
Tax advantages for qualifying home improvements	Your home serves as collateral
Lower closing costs compared to refinancing	A fixed amount means you can't borrow more later

 

HELOC

A HELOC resembles a credit card. It opens a revolving line of credit. You only pay interest on the amount you use, not your whole line of credit.

HELOCs usually have a variable rate, a dedicated draw period (usually five to 10 years, where you can withdraw HELOC funds), and a repayment period (around 10 to 15 years). It’s best for homeowners with cash needs that stretch over an extended period.

HELOC pros	HELOC cons
Pay interest only on funds you use	Variable HELOC rates can increase over time
Flexible access to money as needed	Monthly payments can vary
Usually no or low closing costs	Interest-only HELOC payments during the draw period
Tax-deductible interest for home improvements	Your home serves as collateral

Cash-out refinance

Unlike a home equity loan or a HELOC, a cash-out refinance replaces your home's current mortgage with a new mortgage. The cash-out refinance will provide more than enough money to pay off the current loan. The extra money, borrowed from home equity, goes to the homeowner at closing. 

For example, for a $400,000 home with a mortgage balance of $250,000, the homeowner could apply for a cash-out refi of $320,000. The first $250,000 from the new loan would pay off the old loan; the remaining $70,000 would be paid to the homeowner at closing. 

A cash-out refi works best for a homeowner who can get a better interest rate than they already have on the first mortgage. Find out how much you can get with a cash-out refinance calculator.

Cash-out refi pros	Cash-out refi cons
Typically lower interest rates	Must replace your entire existing mortgage
Single monthly payment instead of two	Higher closing costs similar to the original mortgage
Large lump sum available at closing	May lose your current low mortgage rate
Can change loan terms if beneficial	More complex approval process

Better offers an easy cash-out refinance option that could lower your monthly mortgage payment.

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Alternative ways to get equity out of a home

Most homeowners use one of the three loan types above (HELOCs, home equity loans and cash-out refinances) to convert home equity into cash.

But other possibilities exist:

• Reverse mortgages: Homeowners who are 62 or older can use reverse mortgages to convert home equity into cash. Reverse loans require no payments. They usually provide a lump sum of cash, but more flexible reverse mortgages are also available.
• Home equity agreement: This agreement isn't a loan and it requires no monthly payments. Instead, the homeowner grants a percentage of the home's equity to an investor in exchange for cash. The investor then benefits from future equity growth and will have to be repaid the market value of the equity when the homeowner sells the home.

Borrowers can also choose non-home equity loans like personal loans or credit cards. This type of borrowing is faster and easier than borrowing from equity, but interest rates tend to be a lot higher since there's no risk of home foreclosure. 

How to build equity in a home

Building equity in your home creates long-term wealth and opens doors to future opportunities, all while maximizing your property’s financial potential.

Here are three ways to maximize equity:

• Start with a healthy down payment: Your down payment contributes a lot toward equity on Day 1. The more you can put down, the less you have to borrow for the home, and the less you'll owe for each month's payment.
• Pay extra on the mortgage: Regular, on-time payments build home equity gradually. Extra payments supercharge this repayment process. Some people put their tax return or holiday bonus toward their mortgage principal each year. Others make one extra mortgage payment per year.  
• Invest in home improvements: Expanding or updating your home’s features can increase its value. First understand which improvements increase property value before taking this approach, because you could end up spending more money than the updates are worth.

Market appreciation can also increase home equity: No one can control how the housing market appreciates, but the first three tips above can help homeowners optimize market appreciation when it happens.

FAQs: How to get equity out of your home

How much equity can you borrow from your home?

Lenders limit how much home equity you can borrow. Many cap loans at 80 percent of the home's value (80% loan-to-value or LTV ratio). A $400,000 home could secure borrowing up to $3230,000. Borrower eligibility also plays a role here. Homeowners who have excellent credit, low debt-to-income ratios, and a healthy emergency fund in savings might qualify for larger home equity loans.

How soon can you take equity out of your home?

There's no official waiting period to apply for a home equity loan. But someone who just bought a home with a mortgage may not have enough home equity to support a new loan. Unless borrowers make unusually large down payments, it may take a few years to build enough equity to support a HELOC or home equity loan.

What's the cheapest way to get equity out of your home now?

HELOCs tend to offer the cheapest and most flexible ways to access home equity. HELOCs often charge interest only payments during the first five to 10 years of the loan. Plus, homeowners pay interest only on the amount of the credit line they're using, not the entire credit limit.

What credit score is needed for a home equity loan?

Credit score rules vary by lender and loan, but most home equity loans require a credit score of 620 to 640. 

Make your home equity work for you

Home equity is an asset. Home equity loans, HELOCs, or cash-out refinancing can help leverage this asset to improve your financial life in some way.

You can expand the power of home equity by borrowing at a lower interest rate and with lower upfront fees.

Shopping around with several lenders helps homeowners can help you find a better deal.

...in as little as 3 minutes – no credit impact