Best Ways to Tap Your Home Equity: A Comprehensive Guide (2024)

Home equity is the portion of your home’s value that you own outright. You might be able to borrow against it — giving you the cash you need to pay for major expenses such as home improvements, debt consolidation, tuition bills or emergencies.

If you’re curious about how much equity you have, here’s the quick back-of-the-napkin math: subtract your home’s current assessed value from your outstanding mortgage balance.

A home equity loan and cash-out refinance will allow you to borrow a portion of that home equity as a lump sum. That differs from a HELOC, which works more like a credit card.

The best choice for you depends on your financial goals, long-term plans and overall financial wellbeing. Consider consulting a financial adviser or mortgage professional when making your decision.

Here are three options for tapping your home’s equity.

1. Home Equity Loans

With a home equity loan, lenders give homeowners a one-time installment loan that they can pay over a set time at a fixed interest rate. Home equity loan terms can last as long as 30 years and the money can be used for most any expense. Because these loans are secured by the value of your home, they typically feature lower interest rates than a credit card or personal loan.

But there’s a downside: If you fail to make your payments, you could lose your home to foreclosure.

Like a traditional mortgage, you may face closing costs as well, which can add to the overall expense of your loan.

2. Home Equity Lines of Credit (HELOCs)

A HELOC is a revolving line of credit that gives you cash as needed, up to a predetermined limit. Like a home equity loan, a HELOC is secured by your home, however it also gives you the flexibility to tap the value of your home gradually instead of all at once.

You can take out money during the draw period, typically up to 10 years. That’s followed by a repayment period, generally up to 20 years. Some of the top home equity loan lenders wait until then to collect the principal borrowed, while others allow you to pay a portion of the principal along with interest during the draw period. Your principal refer to the dollar amount you spent, with your total cost being principal plus interest.

Flexibility is a significant benefit of a HELOC. Borrow what you need, repay it with interest, and the credit limit becomes available again, making it convenient for ongoing or unpredictable expenses.

However, you generally pay back a HELOC at variable interest rates tied to current market conditions, which might fluctuate over time and lead to unpredictable payments and potentially higher borrowing costs. Another downside of HELOCs is the temptation to overspend. With any line of credit, payments may seem far away, without consideration of the total interest charges and your ability to repay them. And if you fail to make your payments, you could lose your home to foreclosure.

3. Cash-Out Refinances

A cash-out refinance is a new and larger mortgage that replaces your current one, leaving you with the difference in cash. The money is usually paid as a lump sum.

Once you apply and get approved, the new loan pays off the existing mortgage and leaves you the difference to make home improvements or pay off other debt. You’ll then make monthly mortgage payments on the new, larger loan.

A larger mortgage might increase your overall mortgage debt and extend the time it takes to pay off your home. It’s possible to offset these downsides with a lower interest rate on your new mortgage — keep an eye on the latest mortgage rates — but closing costs will add to the expense of the transaction, as well. The average borrower paid close to $6,000 in closing costs in 2022, according to the most recent data from the Consumer Financial Protection Bureau. Finally, if you fail to make your payments, you could lose your home to foreclosure.

You can use your home equity to fund a variety of large expenditures. Highlighted below are some of the more common uses.

Using your home equity for home improvements, debt consolidation, education or unexpected expenses might be wise financial moves, but it’s not without consequences:

• Potential foreclosure: If you fail to repay your home equity loan, HELOC, or cash-out refinance, you could lose your home. Even if you stay up-to-date on mortgage payments, but neglect your home equity loan, you still put your property at risk.
• Fees: No matter how you tap your home equity, you’ll probably pay for the privilege of borrowing money. Closing costs and interest fees may be worth it for necessary home improvements or investing in a child’s education. If you use the funds for discretionary spending, however, you might be repaying a loan for items that no longer hold value.
• Depletion of equity: Borrowing against your home equity reduces your ownership stake and may limit your financial flexibility in the future. If your property loses value or remains stagnant, you might end up underwater, or owing more on your home than it’s worth. That might make your home harder to sell or borrow against next time.

Nearly 1 million consumers borrowed against their home equity using home equity loans or lines of credit in 2022, according to the Consumer Financial Protection Bureau. Before you join their ranks, conduct a thorough evaluation of your financial health by taking a look at these key factors:

• Credit score: It’s possible to be approved for a home equity loan, line of credit, or cash-out refinance with less-than-stellar credit, but a higher credit score generally leads to better loan terms and rates.
• Income stability: If your income is uncertain or likely to change, have a plan to manage your debt, especially in periods of financial instability.
• Debt-to-income ratio: Lenders assess your debt-to-income ratio (DTI) to determine your ability to handle additional debt. Before applying for a loan, calculate your DTI to gauge how comfortably it fits into your existing financial responsibilities.
• Future plans: Think about how borrowing lines up with your long-term goals. If you plan to sell your home in the next few years, for example, determine if you are prepared to pay off your HELOC or home equity loan.
• Loan terms and costs: Make sure you understand the full cost of borrowing, including closing costs, interest rates and potential prepayment penalties.
• Risk tolerance: Tapping home equity means putting your home on the line. If unforeseen circ*mstances arise, you’ll need to know whether you are prepared to handle potential financial setbacks.
• Alternative options: Home equity isn’t the only way to get needed cash. Explore other avenues for obtaining funds. This will help you make an informed decision that best suits your needs.

>> Related: Learn more about why home equity matters

Home Equity Loan Calculator

Most lenders require a loan-to-value (LTV) ratio of 85% or less to qualify for a home equity loan. Use our calculator to see if you may be eligible to draw on your home equity and how much you might be able to borrow.

Unlocking home equity can serve as a valuable financial strategy if approached thoughtfully. A home equity loan typically allows homeowners to borrow a lump sum at a fixed rate with predictable monthly payments. A HELOC is a revolving credit line with the flexibility to borrow funds as needed within a set period, usually at a variable interest rate. Cash-out refinancing replaces your existing mortgage with a new, larger one, allowing you to receive the difference in cash.

Each option has its own benefits and setbacks, but they all share one thing in common: they use your home as collateral.

Before deciding which route to take, if any, carefully evaluate your financial situation and what’s potentially at stake: depletion of equity, fees and the threat of foreclosure. A financial adviser can help you better understand the potential risks, compare options and weigh the impact on your overall finances.