How to use equity in your home

With every mortgage payment and home upgrade, you've built up the equity in your home. This equity can be a powerful financial tool, allowing you to accomplish what you need to do. 

But given the costs and risks associated with tapping into your home’s wealth, you may be wondering whether it's the right move for you. This post will explore how to use equity in your home and when it makes sense. 

Home equity: A brief overview

Home equity is the piece of your home that you own outright—the difference between your home’s current market value and any debts tied to the property.

For example, if your home is worth $400,000 and you owe $250,000 on your mortgage, you own $150,000 in equity.

How to use equity in your home

Debt management

If you feel underwater from high-interest debt, equity can be a lifesaver. You can consolidate high-interest debt at a lower rate, which can not only help you pay it off faster but also make payments more manageable.

Alternatively, you can tackle other obligations, like auto or student loans, if you wish to have a debt-free retirement. 

Home improvement

Whether you have critical repairs or simply want to elevate your space, home equity can help. Using equity to finance improvements vs. personal loans gives you better rates, access to more cash, and longer repayment periods.

Projects like kitchen remodels, bathroom upgrades, and energy-efficient improvements provide a strong return on investment. Plus, if you ever decide to sell, these upgrades can make your home more appealing and help you secure top-dollar for the property.

Real estate investing

Want to put your home equity to work in a big way? Some homeowners use their equity to purchase rental properties or flip houses. Real estate can be a great way to generate passive income. However, it’s important to plan for property value fluctuations and unpredictable tenants. 

Small business funding

Home equity can be a game-changer for budding entrepreneurs or those looking to expand. Business loans come with steep interest rates and rigid terms, which can make qualifying a challenge. Instead, equity offers a more accessible way to get capital. 

Education costs

Whether you want to cover private school costs for children or help lessen the burden of college tuition for another, there's no restriction on how you can use equity to fund education. 

Alternatively, you can invest in yourself by pursuing higher degrees or workshops—which is a great way to focus on career growth and build wealth. 

Retirement income

Retirement should be a time of enjoyment, not financial stress or constraints. If you think you'll approach retirement with little to nothing saved, equity can provide supplemental income. On the other hand, if you feel there's little room to pursue dreams or travel opportunities, equity can bridge the gap. 

Major expenses

Life happens—and sometimes it's expensive. If you're saddled with an unexpected medical bill or suddenly find yourself stepping into the role of family caregiver, home equity can be a much-needed financial safety net. Not only can this provide peace of mind, but it can also safeguard you from taking on debt. 

How to tap into your equity

While building home equity in a home unlocks many opportunities, accessing it isn’t as simple as withdrawing money from a savings account.

Lenders will require an appraisal of the property, check your financial health, and even then, only allow you to borrow up to 80-85% of the property’s value, minus your existing mortgage balance. That’s why understanding your options is crucial.  

HELOC

A home equity line of credit (HELOC) is like a credit card backed by your home—you can borrow what you need, when you need it, up to a set limit. During the draw period, you'll be responsible for interest-only payments. Once the repayment period begins, the line closes, and you'll pay back the balance plus interest. HELOCs carry variable interest rates, which means your payments may fluctuate.

• Lenders typically look for a credit score of 680 or higher, a debt-to-income (DTI) ratio of 43% or less, and sufficient income and equity.
• Best for ongoing expenses like home renovations or tuition payments.

Home equity loan

A home equity loan is a lump-sum loan with a fixed interest rate. Rates tend to be lower than credit cards and personal loans, with repayment ranging from 5 to 30 years.

• To qualify, a credit score of 680 and a DTI of less than 43% is preferred, plus 20% equity.
• Best for one-time large expenses, such as debt consolidation or major home repairs.

Home equity investment

With a home equity investment (HEI), you tap into your wealth for a single lump sum payout. There are no monthly payments over a flexible 30-year term. Instead, you share a slice of the home's appreciation when you decide to pay back the investment, which can be done through a home sale, refinance, or using another source of funds.

• You'll need a credit score above 500 and sufficient equity to qualify. Income is not a factor.
• Best for homeowners who need cash but want to avoid traditional loans or strict requirements.

Cash-out refinance

Refinancing allows you to replace your existing mortgage with a new, larger loan and take the difference in cash. Since you're effectively changing your mortgage loan, you'll also get a new rate and term.

• Lenders look for a minimum credit score of 620, a DTI of 45% or less, and 20% equity.
• Best for homeowners looking to secure a lower mortgage rate while also accessing equity.

Reverse mortgage

A reverse mortgage offers homeowners aged 62 or older the opportunity to leverage their equity for a lump sum, line of credit, or monthly payouts. The loan plus interest is due when the borrower passes away, moves, or sells the home—there are no monthly payments.

• To qualify, you’ll need to own a substantial amount of equity, live in the home full-time, and have sufficient income. 
• Best for retirees who want to supplement their income while staying in their homes.

Frequently asked questions

Is it a good idea to take equity out of your house?

Whether or not leveraging equity makes sense depends on your financial situation and how you intend to use the funds. If you're investing in something that will increase your wealth, it can be a smart move. If you're using it to fund a vacation or lifestyle inflation, maybe not. Ultimately, it’s important to weigh your risk tolerance against the return on investment. 

What are the downsides of using equity?

Before tapping into your home equity, it's important to consider the disadvantages. First, it's not as cheap as other loan options. Closing costs tend to add an additional 3% to 5% of the loan amount, plus there are fees. Another drawback is the potential for an underwater mortgage. If home values drop, you could owe more than your home is worth, which will make it difficult to refinance or sell the property. And most consequently – your home is used as collateral, meaning you risk foreclosure if you default on the loan. 

Final thoughts

Your home equity is a powerful financial tool that, when wielded correctly, can unlock better financial stability and peace of mind. Whether you’re looking to eliminate debt, renovate your home, or live out the golden years of your dreams, it's worth exploring how your home equity can help. Just be sure to use it responsibly—your home should work for you, not against you.

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