5 Steps to Take Before Leveraging Your Home Equity  

Key Takeaways:

• Before deciding to tap home equity, it’s important to understand what you want to accomplish with the wealth you’ve built in your home.

• Calculating how much home equity you have will help determine what you can achieve and the best way to access that equity.

• Accessing home equity with or without a monthly payment is possible for homeowners looking to pay for renovations, finance education expenses or meet other financial goals. 

If you’ve owned your home for several years, chances are good that you’ve built up a substantial amount of equity in it. Chances are also good that you’ve heard about how you could access that equity as a source of cash – money you could use to achieve goals you have, from helping to build a business to making home improvements. 

Accessing home equity is a major financial decision. Here, we’ll take a look at the steps you can take to determine if and how accessing your home equity is the right move for you. 

Step 1: Assess Your Home Value and Home Equity

If you are interested in accessing your home equity, the first thing to do is to figure out how much your home might be worth and how much equity you have in your property. To determine your home’s value, start by finding estimates. Third-party online real estate platforms can be helpful sources. You can also visit the website of your county assessor’s office (or other property recording office, as applicable in your state) to check recent sales prices of homes very similar to yours. These estimates are just that: estimates. They don’t replace an independent appraiser’s valuation of your home, but they can serve as good indications of your home’s current market value. 

Once you have an idea of your home’s estimated value, you can calculate your home equity. Home equity is simply a measure of how much of your home you own outright. It’s the current value of your home minus any debt you have on the property. So, if your home is worth $500,000 and you have a $300,000 mortgage (and no other loans on it), you have $200,000 of equity. 

Be sure to not only factor in the amount you have left on your mortgage, but also a home equity line of credit (HELOC), home equity loan (HEL) or any other obligation tied to your property. To do so, check your monthly statements or your online account balances, or contact your loan servicer directly. With these figures in hand, subtract the debts from the market value. The remainder will be an estimate of how much home equity you have.  

Knowing how much equity you have can help you decide which methods of accessing your home equity might work for you. For traditional loan options, like a HELOC or home equity loan, you’ll generally need at least 15%-20% equity in your home. That means the total amount you owe can’t exceed 80%-85% of your home’s value. For home equity agreements or HEAs, you may need at least 30% equity in your home to qualify. A reverse mortgage, which is open to homeowners 62 and older, usually requires at least 50% equity.

Step 2: Consider Your Financial Health

Consider your financial health. Before you embark on accessing equity, it’s wise to take a look at your financial situation and some of the metrics lenders typically use to evaluate your financial health, including your credit profile, credit report, debt-to-income ratio (DTI) and loan-to-value ratio (LTV) Familiarizing yourself with these terms will help you understand how they might influence how much equity you can access, and through which option.

Your credit profile can tell lenders and others a lot about how likely you are to make on-time loan payments and about your overall level of financial responsibility. Both credit reports and scores are components of your credit profile. A credit report is a list of your debts, payments and credit limits over time. It includes credit history, current amount of credit available, current amount of credit in use, and history of on-time (and late) payments. Three major reporting agencies (Equifax, TransUnion and Experian) collect this information and provide credit reports to consumers. Each of those agencies also calculates and reports its own credit score based on the information in the credit reports. It’s important to make sure the information in your credit reports is accurate. You can obtain these reports – at no cost – as often as once a week by visiting www.annualcreditreport.com. If you find any errors, follow the directions provided by each agency to correct them.

If you’re planning on using a traditional loan option to access your home equity, criteria will vary by lender. In general, though, you’ll need a credit score of at least 620. A cash-out refi also typically requires a 620 score or better to qualify.

Income: For traditional loan options, such as a HELOC, HEL or cash-out refinance, lenders generally want to see proof of stable income. Homeowners don’t typically have to provide proof of income when applying for an HEA.  They will also consider your Debt-to-income (DTI) ratio. This is the percentage of your monthly income that goes to debt payments. Lenders of traditional loan products (HELOC, HEL, cash-out refinance) typically require a ratio of 36% or below, though some may accept a higher percentage. Again, each lender is different.

Loan-to-value (LTV) ratio: This refers to the amount you owe on your home, as discussed above. Expressed as a ratio, it is the amount of your existing loans (mortgage and any other loans you have on your home) divided by the value of your home.
 

Step 3: Understand Why You Want to Tap Home Equity

Before you take further steps to access your home equity, you’ll want to review and prioritize your financial goals and decide whether accessing home equity is the best way to reach those goals. Are you looking to make home improvements? Funding an education for a child, grandchild or yourself? Pursuing a dream of starting a business? Maybe you need to pay off debt or tackle some landscaping projects. The key is to have a plan and know how you’ll implement that plan. 

Figure out how much money you’ll need for your projects. If you want to pursue a home renovation, for example, do some research into exactly what it will entail and obtain an estimate of the cost. If you want to start your own business, develop a business plan and outline each step with related costs.  Look, too, at the bigger impact of tapping home equity. If your goal is to pay down debt, will taking on another debt payment alleviate the issue? Accessing your equity can be a smart option, but only if you have clarity on your purpose and goals, and the overall impact on your finances.

Step 4: Research the Options

When you’re ready to move forward, it’s time to review the different ways of tapping home equity and determine which one might be right for you. Here is a look at the options. 

Home equity line of credit: Taking out a HELOC is taking out a loan against the equity you have built in your home. You take out the amount you need, when you need it, up to the limit extended to you. In this way, it works somewhat like a credit card. Most HELOCs are variable-rate loans. That means the interest rate – and therefore the monthly payment – can vary over the life of the loan. While each lender has its own qualification criteria, as discussed, they will evaluate your credit scores, income and debt-to-income ratio.

Home equity loan: Taking out an HEL also is taking out a loan against the equity you have built in your home. You will receive an upfront cash payment, which you will repay monthly at a fixed interest rate. That means that neither the rate nor the monthly payment will change during the loan’s term. The qualification criteria are the same as those with a HELOC.

Cash-out refinance: With a cash-out refinance, you get a whole new mortgage to replace your existing one. The new mortgage is for an amount higher than what you owe on the existing mortgage, and the difference becomes the “cash out.”  Two important considerations in a cash-out refinance are the amount of the new mortgage and the interest rate. It could mean a higher monthly mortgage payment. Plus, obtaining a new mortgage means you do so at current interest rates. Mortgage rates may be decreasing slightly, but they are still much higher than a number of years ago when many homeowners secured ultra-low rates. Unless you bought your home very recently, the rate you’ll get in a cash-out refinance may be much higher than what you have on your existing mortgage.

The application and qualification process for a cash-out refinance is the same as for a first mortgage, involving fees, closing costs, credit checks and documentation. 

Home equity agreement: A home equity agreement (HEA) is an option to access the equity you’ve accumulated in your home that does not involve a monthly payment. You’ll receive cash up front in exchange for a percentage of your home’s future value.  HEA qualification criteria have a lower threshold than do loan-based options. Since credit scores in the 500s may qualify, and income requirements are flexible, HEAs can be great options for retirees, self-employed individuals and others who may not have full-time traditional jobs or income. 

The chart below highlights some key differences between the various options.

Step 5: Prepare Your Home and Documentation:

No matter which option to tap your equity you pursue, you’ll likely need a home appraisal. For best results on your appraisal, address any needed repair and maintenance items. Take time to declutter and give your home a thorough cleaning, inside and out. It can also be a good idea to spruce up the exterior. 

Then figure out what type of documents you’ll need to provide to potential lenders or HEA providers. For instance, you may need to check and see if your home meets underwriting guidelines, and determine if it has any liens on it that could cause issues. Gather insurance documents and homeowners’ association paperwork. Taking these steps ahead of time can help you speed the application and approval process, and avoid any problems. 

Conclusion

Home equity can be a good solution for many problems, opportunities and goals. Home equity agreements such as those Unlock offers are powerful tools that help millions of homeowners who have wealth in their homes achieve their goals – without monthly payments. Whatever your needs and dreams are, take time to consider what you need, why home equity could be a good source of funds and what choices you have to tap that equity.