Key Takeaways
- Home equity can be a powerful financial tool for homeowners looking to achieve their dreams.
- There are traditional methods of accessing equity, like HELOCs and home equity loans, as well as more modern options like home equity agreements.
- You can build wealth for the future by leveraging your home equity to pay off debt, start a business, renovate your home, or invest.
Data insights firm Cotality notes that the average homeowner has about $307,000 in equity in their home – “the third highest figure in recorded history,”
Homeowners often use home equity to build wealth, leveraging their ownership of a major asset – their home – to build the foundation for something bigger. If you have dreams and goals that feel just out of reach, tapping your home equity could be the key to big changes. Learn why and how you can build wealth using your home equity.
What is Home Equity and Why Does it Matter?
Home equity is the portion of your home that you own outright. If you bought your home in cash, or paid off your mortgage loan, you own the whole thing. If you financed your home with a mortgage, your home equity is the value of your home minus the amount remaining on your mortgage.
Real estate is an asset, but not a very liquid one. Collectively, U.S. homeowners are sitting on almost $36 trillion in home equity, but they can’t access it unless they tap it somehow: usually either by selling and reaping the profits, or by borrowing against their stake in the home.1
Once you tap your home equity, you gain access to the value trapped in your home without needing to sell it first. You can use that money for a wide variety of purposes, whether your goal is to pay down debt, build a business, or just make a few home renovations.
Why Use Your Home Equity to Build Wealth?
You may not have generational wealth or a high-paying job, but if you own a home, you have access to a major financial asset.
You could use that money to buy consumer products or take a nice vacation, but those things won’t make you wealthier. Using equity to put yourself in a better financial position, can, though. Home equity provides the average homeowner with capital they can leverage to achieve their goals.
Traditional Ways to Use Your Equity
You’re probably already familiar with some of the traditional ways of accessing your home equity, which consist mostly of conventional loans, but there are some new options worth considering. Here, we review the choices.
Home equity loan
A home equity loan provides a lump sum with fixed interest and payments, using your home equity as collateral.
Interest rates for home equity loans are usually lower than with a personal loan, and loan terms can be as short as five years or as long as 20. You typically need a credit score in the upper 600s or higher to get a home equity loan with reasonable terms. Because you’re borrowing against your home, if you default on your payments, you could face foreclosure.
Home equity line of credit (HELOC)
A home equity line of credit is a revolving line of credit that lets you borrow what you need when you need it.
HELOCs usually have a draw period, where you draw on the credit line that’s backed by your home, up to a certain limit. That’s followed by a repayment period, where you repay what you’ve borrowed, with interest.
To qualify for a HELOC, you’ll often need a credit score in the upper 600s or higher, with lenders reserving their best rates for those with excellent credit. HELOCs often have variable interest rates, so your payment can fluctuate over time. Defaulting on a HELOC could put your home at risk.
Cash-out refinance
A third common option is the cash-out refinance, where you refinance your mortgage for a higher amount and take the difference in cash.
The requirements for a cash-out refi are much like for a conventional loan: you’ll need a credit score in the mid-600s, but higher is better. You’ll also need at least 20% in equity (you may hear this referred to as an 80% loan-to-value ratio, or LTV).
Newer, Flexible Options: Home Equity Agreements (HEAs)
There is another way to access your home equity: a home equity agreement (HEA). An HEA is a newer, more flexible home equity option, that allows homeowners to access equity without monthly payments.
Instead of borrowing against the equity you have now and then making payments on that debt, a home equity agreement gives you cash now in exchange for a portion of the future value of your home. When you sign a home equity agreement, you agree to repay that “advance” on your home equity years down the line, usually when you sell the home.
With its more flexible qualifications, an HEA may be ideal for those with nontraditional income or less-than-perfect credit. You can then use your home equity to fund life goals, invest, or consolidate debt, among other options. Unlock offers home equity agreements that help you access up to $500,000 of your home’s equity, and they’re available for people with a credit score of 500 or higher.
Smarter Ways to Use Home Equity for Growth
Here are a few things you can do when you unlock the equity in your home:
- Pay off high-interest debt: The interest you’re paying on credit card debt and other high-interest debt can hold you back from growing your wealth. Paying it off with home equity funds not only eliminates your interest costs and the amount owed, it ensures that your future income can go toward wealth-building activities instead.
- Fund home improvements that increase property value: Although real estate tends to appreciate over time, improvements, renovations and upgrades can dramatically increase a home’s value. Using your home equity to make those improvements often earns a solid return on the investment. For example, adding a deck or remodeling the kitchen can boost your home’s value by tens of thousands of dollars, and you’ll likely recoup a majority of the money you spent.
- Start a business: Self-employed families have a net worth more than four times higher than employed families, according to the Small Business Administration. You could take out a small business loan to fund a new venture – but you’d need to qualify with the lender, and you’ll still have to make payments on the principal and interest. Using your home equity instead allows you to focus on the business instead of worrying about how you’ll make your payments.
- Boost financial flexibility: Sometimes, you just need a little cash on hand to take advantage of opportunities that come your way. Many homeowners tap their home equity to create a financial buffer, using the cash to cover emergencies like job loss or medical expenses instead of resorting to pricey personal loans. Having access to cash on tap also gives you the freedom to pick up assets for cheap without going into debt. If a parcel of land is suddenly up for auction, or the stock you’ve been eyeing drops to a can’t-beat-it price, you have the liquidity to scoop it up instead of letting the moment pass you by.
Is Using Home Equity Right for You?
There are a few things to think about when considering if now’s the right time to use your equity.
First, think about your risk tolerance. Many of the ways commonly used to tap home equity use your home as collateral – and that means there’s a risk of foreclosure if things go wrong. Make sure you’re financially stable and prepared to make the required payments (if your home equity method requires them).
Also consider your timeline. Have you owned your home long enough to have built up some equity? If you just purchased a home and put down only a small amount, you many not be in a position to tap that equity just yet. And if you think you might sell and move soon, it might make more sense to wait.
Finally, consider your life stage and financial goals. If you’re young, perhaps still building your career or family, having access to your home’s equity could be very important for the freedom and flexibility it provides. On the other hand, older homeowners of retirement age may want to consider whether long repayment periods are desirable, and whether variable interest rates and fluctuating payments are suitable for a fixed income.
Conclusion
As a homeowner, you can use the equity you already have in your home to build wealth for the future and for your family. Whether you want to start a business, boost your savings, or invest for the future, your home equity can provide the launchpad for achieving your financial goals. Unlock’s home equity sharing agreements are a modern, flexible way to access your equity, without monthly debt or interest payments.
