How to get equity out of your home

With home values near all-time highs, many homeowners have a large amount of equity, but they're unsure how to access it. There are many ways to pull cash out of your home, and each financing option has a different interest rate and required monthly payment. In some cases, you can avoid payments entirely or pay just the interest charges. Here's how to get equity out of your home, how much they cost, and factors to consider before applying.

Home equity: A brief overview

Home equity is the portion of your home that you own outright—calculated by subtracting your mortgage balance and any other liens from your home's current market value. As you pay down your mortgage and your home's value increases, your equity can grow over time.

Once you've built a meaningful amount of equity, you may be able to leverage it to access cash. Because your home serves as collateral, home equity products often offer larger borrowing amounts and more favorable rates and terms than unsecured financing options, such as personal loans or credit cards.

Many homeowners use their equity to fund home improvements, consolidate debt, cover education costs, support a business, or create a financial cushion.

How to get equity out of your home

Borrowers have many options to choose from when they want to access their home equity. These real estate loan options have various levels of origination costs, interest rates, and monthly payments. Depending on which loan type you select, you may keep your current mortgage interest rate or replace it with a new one.

Home equity line of credit (HELOC)

A HELOC is a flexible line of credit that gives borrowers a maximum credit limit. HELOCs have a variable interest rate, and monthly payments are interest-only based on how much they borrow. If your balance is zero for the month, you don't have to make a payment. Lenders typically allow borrowers to withdraw money by writing checks, requesting online transfers, making teller withdrawals, or using an ATM card.

HELOCs typically have a 10-year draw period, where you can withdraw cash and pay it back as many times as you like. As you repay the balance, you free up available credit for future transactions. At the end of the draw period, any outstanding balance is converted to a fixed-rate term loan. During the repayment period, borrowers make principal and interest payments over a typical 20-year term.

Home equity loan

A home equity loan provides a lump sum of cash to borrowers. The loan has a fixed interest rate and a constant monthly payment. Loan terms typically range from five to 30 years, depending on the lender, loan amount, and borrower needs. The loan will have a zero balance at the end of the term, assuming that all payments were made on time.

Home equity investment

A home equity investment (HEI) is a unique financing option that doesn't require monthly payments, income verification, or the need for perfect credit. The homeowner receives a lump sum of cash, and, in return, it allows the lender to participate in the home's appreciation. 

The investment is repaid when you sell or refinance the home or at the end of the 30-year financing agreement. However, you can settle the investment at any time.

Cash-out refinance

For homeowners with a higher rate on their current mortgage, a cash-out refinance may make sense. This loan option replaces your current loan with a mortgage that has a higher balance. The new interest rate is based on today's rates, so it may not make sense for borrowers with an ultra-low mortgage rate on their current mortgage.

Lenders tend to charge a slightly higher rate for a cash-out refinance than a regular mortgage rate-and-term refinance. When doing a refinance, the loan term resets, so many borrowers consider taking a shorter term than 30 years to stay on track for paying off the mortgage on the original timeframe. However, a shorter term may increase your monthly payments.

Reverse mortgage

Reverse mortgages are available to seniors ages 62 and older who live in their primary residence. This financing option gives homeowners the choice of a lump sum of cash, a monthly annuity payment, or a line of credit. Reverse mortgages do not require monthly payments, but homeowners are still responsible for property taxes, insurance, and general upkeep. Interest charges accrue each month and increase the outstanding balance.

If you move out of the home for an extended period, the loan must be repaid in cash, through a home sale, or by refinancing. Reverse mortgages tend to have higher closing costs than a traditional mortgage. However, they can be a good option for seniors who

Home sale

Selling your home gives access to your home equity, but there's no guarantee of when it will sell or for how much. Plus, you'll need to move and find a new place to live. Selling your home also comes with real estate commissions, home repairs, and other costs that can drive up your overall costs. Homeowners often go this route if they cannot afford the payments, are looking to buy a different home, or are moving to a new location.

What to consider before tapping your equity

Before taking cash out of your home equity, it pays to understand how these loans may affect your finances. Here are a few factors to consider when choosing a loan type or using your home equity at all.

• Your home is at risk if you can't make payments. Since all of these loan options use your home as collateral, you can lose your home if you are unable to make your monthly payments.
• Fixed vs. variable interest rate. Fixed interest rate loans tend to have a higher rate, but they do not change for the life of your loan. Variable interest rates may start out lower, but if rates rise too quickly, you may have trouble fitting the payment into your budget.
• Interest may be tax-deductible. The interest charges may be tax-deductible if the money is used to buy, build, or improve your home, up to maximum loan limits. Consult your tax advisor to see if you qualify.
• Closing costs. Each loan type has different closing or origination costs, and some lenders may waive them as long as you keep the loan open for a period of time. Your lender may be able to bump up your rate or add them to your loan balance to keep your out-of-pocket costs low.‍
• Credit score. Home equity loans typically require Good to Excellent credit, but some loan types allow borrowers with less-than-perfect credit, such as home equity investments (HEI).