Are you facing a financial crunch or looking for ways to access funds? The equity in your home might just be the solution you’re searching for. Home equity has become a significant resource for many homeowners, particularly in a rising real estate market. By accessing this equity, you can unlock funds without selling your home or relying on high-interest personal loans.
In this article, we’ll explore the main methods to tap into your home’s equity and how to choose the best option based on your financial goals.
Written By: Sandeep Bishnoi
Last Update : Sep 11, 2024
Key Points
- Home Equity: The difference between your home’s current value and the remaining mortgage balance.
Ways to Access Home Equity:
- Home Equity Loan: Borrow a lump sum with fixed interest; ideal for large, one-time expenses.
- Home Equity Line of Credit (HELOC): A revolving credit line; flexible for ongoing expenses like home improvements.
- Cash-Out Refinance: Refinance your mortgage for a larger loan and take the difference in cash.
- Best Use Cases: Debt consolidation, home improvements, emergency expenses, or education.
- Borrowing Limits: Typically 80%–85% of your home’s available equity.
- Tax Deduction: Only available if the funds are used to “buy, build, or improve” the property.
- Risks: Failure to repay could result in losing your home through foreclosure.
What is Home Equity?
Home equity is the difference between your home’s current market value and the outstanding balance of your mortgage. For example, if your home is worth $400,000 and your mortgage balance is $150,000, your home equity would be $250,000.
3 Primary Ways to Access Home Equity
- Home Equity Loan
- Home Equity Line of Credit (HELOC)
- Cash-Out Refinance
Read More: Pros And Cons Of Savings Account
Home Equity Loan
A home equity loan is often referred to as a second mortgage. It allows you to borrow a lump sum based on the equity you’ve built up in your home, and it comes with a fixed interest rate and set repayment terms—typically 10 to 20 years.
Advantages:
- Fixed interest rate: Stability in payments for the life of the loan.
- Lump sum: Ideal for large, one-time expenses like home improvements or medical bills.
Disadvantages:
- Higher interest rate: Compared to your primary mortgage, home equity loans usually have slightly higher rates.
- Potential foreclosure Risk: Failure to make payments can result in losing your home.
A home equity loan is best if you need a large, one-time amount of cash and prefer predictable payments.
Home Equity Line of Credit (HELOC)
A HELOC works much like a credit card, providing a revolving line of credit that you can borrow from as needed. The interest rate is typically variable, meaning it can fluctuate with market rates.
Advantages:
- Flexibility: Borrow only what you need and pay interest only on the amount you use.
- Lower costs: Often, HELOCs come with minimal or no closing costs.
Disadvantages:
- Variable interest rate: Payments can increase if interest rates rise.
- Potential for overspending: Since you have constant access to the funds, it’s easy to borrow more than you originally intended.
HELOCs are ideal for ongoing expenses like home renovations or launching a small business, where you’ll need access to funds over a period of time.
Cash-Out Refinance
A cash-out refinance allows you to replace your existing mortgage with a new, larger loan. You receive the difference between the new loan and what you currently owe in cash. This option is typically used when you want to access equity and also take advantage of lower interest rates.
Advantages:
- Potential lower interest rate: If rates have dropped since you first took out your mortgage, this could lower your overall payments.
- Consolidation: You can consolidate higher-interest debt, like credit cards or car loans, into your mortgage, potentially reducing your monthly payments.
Disadvantages:
- High closing costs: Refinancing can involve significant fees, which can eat into your equity.
- Longer repayment: You could end up extending the time it takes to pay off your home.
Cash-out refinances are great if you’re looking for a large lump sum and can potentially get a better interest rate than your current mortgage.
When Should You Tap Into Your Home’s Equity?
While using your home’s equity can provide much-needed cash, it’s important to ensure that you’re borrowing for the right reasons. Here are some smart reasons to consider accessing your home equity:
- Debt Consolidation: If you have high-interest debts (like credit cards), home equity can be a cheaper way to pay them off.
- Home Improvements: Projects that increase your home’s value, such as kitchen or bathroom remodels, can provide a return on investment.
- Emergency Expenses: Medical bills or urgent repairs can sometimes warrant the use of home equity.
- Education: Some homeowners choose to use their home’s equity to fund education costs, which can pay off long-term.
How Much Equity Can You Access?
Most lenders will allow you to borrow up to 80%–85% of your home’s equity. For instance, if your home is worth $400,000 and you owe $150,000, you may be able to borrow up to $200,000 in equity.
How to Build Equity in Your Home
Building equity takes time, but there are ways to accelerate the process:
- Make extra mortgage payments: Paying a little extra toward your mortgage each month can shorten your loan term and build equity faster.
- Home improvements: Smart renovations can increase your home’s value, thus increasing your equity.
- Real estate appreciation: Your home’s value will naturally rise over time, further boosting your equity.
Tax Implications of Home Equity Loans and HELOCs
Due to the Tax Cuts and Jobs Act of 2017, you can only deduct interest on home equity loans or HELOCs if the funds are used to “buy, build, or substantially improve” the property. If used for other purposes, such as debt consolidation or paying for education, the interest won’t be deductible.
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FAQ’s
Is pulling equity out of your house a good idea?
Extracting home equity can be beneficial for significant expenses. However, it’s crucial to weigh costs, potential impact on your home’s value, and your financial stability before proceeding.
Can I take out equity if I own my house?
Absolutely, owning your house outright gives you the advantage of accessing a larger portion of your home equity. Various methods, like home equity loans or cash-out refinancing, can help you achieve this.
How can I get equity out of my house without refinancing?
You can tap into your home equity without refinancing through options like home equity loans or lines of credit, which provide funds without altering your existing mortgage arrangement.
Bottom Line
Using your home equity can be a powerful financial tool, but it’s not without risks. Make sure that you have a solid repayment plan in place, and only borrow what you truly need. Whether it’s for home improvements, debt consolidation, or an emergency, tapping into your home’s equity can provide financial relief without the need to sell your most valuable asset—your home.
However, remember that home equity debt isn’t suitable for everyday expenses or luxury purchases. Misusing it can put your home at risk. Always consult with a financial advisor or mortgage expert before making any decisions.
