Using Home Equity Wisely

Key Takeaways  

• Home equity is the portion of your home that you own outright. 
• To calculate your home equity, take the market value of your home and subtract the remaining balance of your mortgage. 
• To access your home equity, you can use a home equity loan or line of credit, a cash-out refinance, a home equity agreement, or a reverse mortgage. 
• Choosing the right strategy depends on your budget and your future goals. 

Homeowners in the U.S. have an average of $303,000 in home equity as of 2024, according to a report from data intelligence firm Cotality. That’s a lot of money that could be put to good use. Whether you want to pay off high-interest debt, cover college costs, or simply fix up your home, there are multiple ways to use your home equity wisely. We’ll go over different methods of turning home equity into cash, so you can make informed decisions about your finances.  

How does home equity work?

Home equity is your ownership of the home. If the home is paid off, you have 100% equity. But if you are still paying on a mortgage, your equity is the value of the home minus what you still owe on the mortgage. In other words, if your home is worth $500,000 but you still have $300,000 remaining on your mortgage, your equity is $200,000.  

There are two main ways of increasing home equity: when the value of the home goes up, and when the balance on your mortgage goes down. The most common path is by making your mortgage payment each month, which slowly but surely decreases what you owe. In a hot real estate market, the value of your home may shoot up quickly, which can also boost your equity.  

Return to our previous example. If your home was worth $500,000 but now is worth $750,000, your equity just went from $200,000 to $450,000.

What can you do with home equity?

Your home is an asset – perhaps one of the biggest assets you’ll own in your lifetime. You can use your equity in that asset to access cash for a wide variety of purposes. A few of the things you can use home equity to do include: 

• Pay off debt 
• Fund home improvements 
• Cover education expenses 
• Finance a business 

How to turn your home equity into cash?

There are several ways to access cash using your home equity. You can put your home equity down as collateral and then borrow the money through a home equity loan (HEL), a home equity line of credit (HELOC), or a cash-out refinance. Each of these will require monthly payments with interest as you pay back the loan. 

There are also two ways to get cash without monthly payments: home equity agreements (HEAs) and reverse mortgages. 

A home equity agreement is a way to access home equity without a loan. This could be a good option for homeowners who want to avoid monthly payments and interest, or those who may have trouble qualifying for conventional loans. 

A reverse mortgage gives you money, and you don’t pay it back until you move out or sell the home. 

Benefits and risks involved in tapping home equity

There are advantages and disadvantages to each method of tapping your home’s equity. The right one depends on which risks you are willing to take, and which benefits you’re looking for.  

Home equity loan

A home equity loan lets you borrow against your home equity, usually giving you a large lump sum and then charging fixed monthly payments with interest. 

• Pros: With fixed interest and fixed payments, you know what to expect over the life of the loan. You can usually borrow up to 80% of your home equity, and interest rates are lower than with other types of loans since you’re putting down your house as collateral.  
• Cons: If you default on a home equity loan, you risk losing your home. You’ll need to make sure you can keep up with the payments for as long as you have the loan. There are often closing costs and fees associated with home equity loans. 

Home equity line of credit

With a home equity line of credit, you get access to a revolving line of credit instead of receiving all the cash up front in a lump sum.  

• Pros: HELOCs usually have a draw period, where you draw the money you need, and a repayment period, when you pay it back. This gives you greater control over what you borrow and how much it will cost you, since you only owe interest on what you borrowed. 
• Cons: HELOCs often have variable interest rates, which means the interest you owe, and your payment, can go up or down over time. And just like with a home equity loan, your home is on the line if you fail to make payments. 

Cash-out refinance

While home equity loans and lines of credit are usually secondary to your primary mortgage, a cash-out refinance replaces it. With this type of refinance, you borrow more than you need to pay off your existing loan and receive the extra in cash. Then you make payments as you normally would until the refi is paid off. 

• Pros: Receive a large lump sum up front and make just one monthly payment. Plus, the interest rate for a refi may be lower than for a home equity loan or HELOC. 
• Cons: Once again, your home is at stake if you default. Also, since it’s a whole new mortgage, you’ll need to qualify all over again, plus pay closing costs. Your loan term starts over as well. 

Home equity agreement

A home equity agreement is not a loan, so there is no monthly payment or interest charges. Instead, you receive a lump sum of cash in exchange for a portion of your home’s equity in the future. 

• Pros: Access your equity without adding to your debt or changing your monthly spending. Plus, the requirements to qualify are much more flexible than with home equity borrowing or a new mortgage, so it’s suitable for people without great credit.  
• Cons: You’ll have to give up a portion of your equity down the road when the agreement is over. Also, there may be a fee to pay upfront. 

Reverse mortgage

Reverse mortgages are generally for homeowners age 62 and older, and they’re sometimes called home equity conversion mortgages (HECMs). When you take out a reverse mortgage, the lender pays you – either in a lump sum or in monthly installments. As time goes by, interest accrues on the balance you’ve received. You can stay in your home as long as you like, but when you leave, sell, or pass away, the entire loan balance plus interest must be repaid to the lender, usually through the sale of the home. 

• Pros: No monthly payments, and you can use the money to supplement your income without being taxed on it. 
• Cons: You won’t be able to leave your home to your heirs unless they repay the reverse mortgage in full, including the interest. Reverse mortgages eat up your equity and add to your debt, and you need to meet age requirements and other criteria to qualify. 

What questions should I ask before deciding to tap home equity?

Make sure you’re ready for this step by asking yourself a few important questions first: 

What will I use the funds for? Knowing what you want to spend the money on will help you figure out the right amount of equity to tap, as well as how you’ll afford to pay the money back. 

What will it cost? You’ll want to make sure you can comfortably afford the costs associated with tapping your home equity for cash. Take a close look at the fees, interest rates, closing costs and other expenses for the home equity method you choose. 

How will this decision affect my future? Know the risks involved in using home equity. If you use your home as a collateral on a home equity loan, for example, you risk losing it if you default later. On the other hand, using home equity to pay off debt could put you in a better financial position. 

Unlock can help you access your equity for whatever you’ve got in mind, offering access to up to $500,000 with no monthly payments or interest.

FAQs

Q. How do I calculate home equity?
A. To calculate your home equity, find your home’s market value, which is how much you could sell it for if you put it on the market today. Subtract your remaining mortgage balance from that amount. What’s left is your home equity. The example below shows how the calculation works.

Q. Can I use home equity for anything I want?
A. Yes, your home equity is yours to use as you see fit. Many homeowners use their equity as leverage to improve their homes, pay off debt or build an emergency fund.

Q. If I want to use my home equity, do I have to take out a loan?  

A. Not at all. While a home equity loan is one way to access the equity in your home, it comes with interest charges and monthly payments. You can avoid that by accessing your home equity through an HEA, or home equity agreement, instead.