When you take equity out of your house, you’re taking out a loan that borrows against the paid-off portion of your home. The three most common ways to access cash from your home’s equity are through a home equity loan, a home equity line of credit, aka HELOC, or a cash-out refinance.
Each loan has its advantages and disadvantages. The proper method for you depends on your financial situation, including your credit score and income, as well as how much equity you’ve built up in your property.
Here’s what you need to know about getting equity out of your house to access cash.
What is home equity?
Home equity is the difference between the current market value of your home and the remaining balance on your primary mortgage or other home loans. It’s expressed as a percentage of the house you own outright.
If you make a down payment of 20% of the home’s price, you’ll have 20% equity in your home. As you pay off your mortgage, your equity will increase. Home equity levels can also be affected by broader housing market trends. For example, if your home’s value has appreciated since you purchased it, that will also increase your home equity.
If you’re going to tap into your home’s equity to borrow cash, most lenders require you to have at least 15% to 20% equity in your home before approving you for a second mortgage loan.
3 ways to take equity out of your house
There are three main ways to unlock your home’s equity and turn it into cash for purposes like home renovations and remodeling or debt consolidation.
Home equity loans
A home equity loan provides you with one lump sum payment at a fixed interest rate on a set repayment schedule. This means you’ll have predictable payments over the lifetime of your loan, and even if rates continue to climb, your personal rate won’t increase.
Pros and cons of a home equity loan
Tax-deductible interest. If you use it for home renovations or improvements, you can deduct the interest from your taxes.
Two mortgage payments. Because it doesn’t replace your mortgage, you’ll have two separate monthly payments.
A HELOC is a revolving line of credit that functions like a credit card. You can make repeated withdrawals over time (instead of receiving one lump sum), but your loan will have a variable interest rate, which means your rate (and monthly payments) will fluctuate based on economic conditions.
Pros and cons of a HELOC
Flexible draw period. You can continually take out money during your draw period, which is usually around 10 years.
Higher payment during repayment period. Once your draw period ends, you’ll have higher monthly payments when you start paying back the principal.
A cash-out refinance doesn’t require you to apply for a second loan against your house like a home equity loan and a HELOC (which are commonly referred to as second mortgages). Rather, a cash-out refi replaces your existing mortgage with a new mortgage loan that has a new lower rate and new terms. But as a result of the Federal Reserve aggressively hiking interest rates since March 2022, fewer homeowners can get a lower rate by refinancing.
Pros and cons of a cash-out refinance
Potential tax benefits. You can take advantage of tax benefits if you use the cash to fund home improvements.
Lengthy closing. It could take lenders around two months to close on a refinance.
How to determine your home equity
Since your equity is based on the current value of your house, you’ll need a home appraisal for the lender to determine how much available equity you can borrow against. Most lenders typically want to see at least 15% to 20% equity built up in your home before approving you for a second mortgage.
To calculate your home equity, subtract your existing mortgage balance from the appraised value of your home. If, for example, you owe $280,000 on your mortgage and your house is worth $400,000, then you’ve paid $120,000 and have 30% equity in your home.
|Outstanding mortgage balance
|Home equity estimate
|$120,000 or 30% equity
Try using a home equity calculator to see whether you have enough equity to qualify for a loan.
How to calculate your loan-to-value ratio
Next, calculate your loan-to-value ratio, or LTV ratio, which is your outstanding mortgage balance divided by your home’s current value. The calculation for that $400,000 property would be:
$280,000 / $400,000 = 0.70
That means you have a 70% LTV ratio.
A typical lender will let you borrow around 75% to 90% of your available home equity. To figure out how much you can borrow, do the following calculation, which assumes a lender is letting you borrow up to 85% of your home equity:
$400,000 [current appraised value] x 0.85 [maximum equity percentage you can borrow] – $280,000 [outstanding mortgage balance] = $60,000 [what the lender will let you borrow]
Your combined loan-to-value ratio, or CLTV ratio, is your current mortgage balance divided by all of your mortgage liens combined if you’ve taken out other loans against your home in addition to your original mortgage. Most lenders prefer a CLTV of 85% or lower.
Determine how much money you want to take out of your house
Depending on what you’re using your funds for, you’ll need different amounts of money. A small home office renovation, for example, may cost only $20,000 and take two months. But if you’re using a HELOC or home equity loan to pay off $300,000 in college tuition over four years, you’ll need a much larger loan amount and an extended repayment period. Lenders offer different rates and terms, so make sure to shop around and compare rates to get the best deal for your personal financial situation.
What are the benefits of taking money out of your house?
Tapping into your home equity can let you access large amounts of cash to help you get out of debt or pay for a major life expense. Plus, if you use the funds to renovate your property, you’re increasing the value of your home, which ultimately increases your net worth.
Home equity loans and HELOCs also tend to offer lower interest rates than other types of borrowing. When your house is used as collateral to secure your loan, it allows your bank or lender to offer you a lower interest rate than an unsecured loan, such as a personal loan.
What are the risks of taking money out of your house?
Your home is on the line when you take out any type of home equity loan, which is no small consideration. If you miss payments or default on your loan, your lender can repossess your property or foreclose on your house. That’s why it’s especially important to consider whether you can manage a high line of credit over a long period of time, and if home equity loans are a wise choice for you.
“Taking money out of your home isn’t the same as going to the ATM and taking money out of your bank account,” said Greg McBride, chief financial officer at Bankrate, CNET’s sister site. “This is borrowing, which must be repaid in full, with interest, and using your home equity as collateral in the event of default.” While some homeowners might look at home equity as “found money,” it’s another monthly payment to your budget, which limits your financial flexibility, McBride said.
Other factors to consider when taking equity out of your house
There are other considerations to keep in mind when you pull equity from your house:
- Home equity rates fluctuate: As of late 2023, all borrowing rates are high, though rates could start to stabilize in 2024. Still, rates on home equity loans and HELOCs are lower than personal loans and credit cards. For current rates, see our home equity loan and HELOC rates pages, which are updated weekly.
- Your property value change: Your home equity is impacted by market conditions. If home prices rise or fall, so does the level of tappable equity in your home. Home prices appreciated during the pandemic and are unlikely to come down dramatically any time soon.
- Your house is on the line: Because your property secures your loan, if you can’t pay back your loan, your lender is entitled to take ownership of your house.
How to apply for a home equity loan or HELOC
Applying for a home equity loan or HELOC is similar to applying for a mortgage. Here are the steps:
Research lenders and compare rates. Once you’ve decided to take out a home equity loan or HELOC, it’s time to contact a lender. As with any loan, interview multiple lenders to get the lowest rates and fees. Experts recommend comparing at least three offers before applying. When comparing rates, be sure to factor in annual fees, closing costs and rate discounts for automatic payments.
Gather your financial documents. Prepare your paperwork on pay stubs, W-2s, proof of ownership and the value of your home.
Get a home appraisal. Some lenders require (or recommend) you get a home appraisal to confirm your current property value.
Complete the application. The application process is similar to the one you went through to get your original mortgage. It will require documentation to prove your income, your home value and credit score. Lenders will also ask how much you have left to pay on your primary mortgage and about any other debts you have.
Close on your loan. There isn’t much else to do once you submit your application. The lender will evaluate your documents and decide whether to approve you for the loan. From there, it can take between 30 to 60 days to close on your loan and get your money.
Read more: Requirements for a Home Equity Loan or HELOC in 2023
Alternatives to using home equity for financing
Home equity loans and HELOCs can work for many homeowners, but they aren’t the only options. Here are a few alternatives to consider if you need to borrow money:
0% introductory APR credit card
If you need a loan to consolidate high-interest debt, balance transfer cards let you combine your debts onto one credit card with a 0% introductory APR period. Balance transfer cards usually offer no interest for an initial 12 to 18 months. Make sure you have a plan to pay the card’s balance off within that window, or you’ll end up with a high interest rate when the introductory period ends.
A reverse mortgage is a type of loan for homeowners ages 62 and older, where they can use their home’s equity to draw out cash in either a lump sum or regular installments. Unlike with a traditional mortgage, borrowers aren’t required to make monthly payments with a reverse mortgage. Instead, the loan is usually paid off when the homeowner sells the property, moves or dies.
If you want to avoid putting your home up as collateral, a personal loan is a good alternative to a home equity loan or HELOC, though rates tend to be higher.