There is a slew of reasons why you may want to borrow from your home’s equity. It’s a potentially low-cost way to fund things like home repair, emergency expenses, debt consolidation, and more. Depending on the amount of equity you’ve built, you may also have access to more money than you could get from a traditional personal loan.
Generally speaking, there are five ways to access your home equity:
- Home equity loan
- Home equity line of credit (HELOC)
- Cash-out refinance
- Reverse mortgage
- Home equity investment
The best mortgage lenders offer many of these options. We’ll examine each of these options to help you decide which is best for your situation.
What is home equity?
Home equity is simply the value of your home minus the outstanding balance on your mortgage. For example, if your home is appraised at $400,000 and you have $100,000 left on your mortgage, you’ve got $300,000 in equity.
It’s worth noting that your home may currently be worth more (or less) than the amount you originally took out on your mortgage. Things like home renovations, housing market performance, even changes to the surrounding area can affect your home’s value.
5 ways to access your home equity
There are multiple ways to borrow from your home equity. Here’s a quick explainer to show you how each works.
Home equity loan
Also known as a second mortgage, a home equity loan is strikingly similar to a standard personal loan with a fixed interest rate. Upon account opening, you’ll receive a lump sum of money deposited into your bank account that you can use however you please.
You’ll be enrolled in a payment plan of equal monthly installments until your loan is repaid, interest included.
Home equity line of credit (HELOC)
A home equity line of credit works more like a credit card. Instead of a lump sum depositing into your bank account upon account opening, you’ll be given access to a revolving line of credit that you can use, repay, and reuse as often as you like.
A HELOC is divided into two phases:
- Draw period: Often lasting several years, this is the period in which you can spend.
- Repayment period: After the draw period, you’ll be obligated to repay any outstanding debt you owe—either all at once or in equal monthly installments. The repayment period can last decades.
A unique aspect of a HELOC is that you’ll only pay interest for the amount of money you actually use. In other words, if you’ve got a $200,000 credit limit but a balance of just $5,000, you’ll only pay interest on $5,000. HELOC interest rates are typically variable.
Cash-out refinance
Instead of adding an additional payment to your existing mortgage, you can refinance your mortgage for more than your current loan balance—and pocket the extra money. To use the above example, if your home is worth $400,000 and you’ve got $100,000 left on your mortgage, you may refinance your mortgage for $300,000. This would give you $200,000 in excess funds deposited into your bank account. This is called a cash-out refinance.
You’d then effectively repay the equity you’ve borrowed over the new term of your mortgage, which could be 30 years. If your monthly payment doesn’t increase, this is potentially a good way to borrow money without raising your debt-to-income ratio. It can ultimately cost you a wild amount of interest unless you pay off your mortgage early.
Reverse mortgage
Saved for retirement-age homeowners (as young as 55 and as old as 62, depending on the loan type), a reverse mortgage lets you borrow equity that you’ll pay back when you sell your house. This effectively lowers your home’s equity—meaning that you’ll get less money when you sell, as the loan will be repaid from your profits.
With a reverse mortgage, you’ll stop making monthly mortgage payments. The bank lends you enough money to pay off your mortgage, and it gives you extra cash in the form of either a lump sum, a monthly payment, or a line of credit.
Shared-equity / home equity investment
In some cases, it’s possible to borrow from your home equity without paying a dime in interest.
Here’s how it works: An individual or company can invest in your property by giving you a lump sum for a percentage of your home’s future value, with the expectation to be repaid at a specific time. You can spend that money as you please, but at the agreed-upon time (or if you sell your home before then), you’ll repay their percentage based on your home’s current value.
Pros and cons of accessing your home equity
Pros
- Potentially borrow a higher amount than a standard personal loan
- Interest rates often lower than a personal loan
- Multiple loan options to choose from
Cons
- Extra loan payment in addition to your current mortgage
- If you default on your loan, the bank may take your home
- Closing costs can be expensive
How to choose the right home equity option for your situation
Each method for borrowing from your home equity has its own advantages. Ask yourself the following questions to narrow down which option is best for your unique goals.
Do you plan to make a series of large purchases over time?
In some cases, the financing you need will come in phases. As an example, those remodeling a house may work on the kitchen before moving to the living room.
In this case, taking out a standard lump-sum home equity loan may not make the most sense, as you’ll be paying interest on the entirety of your remodel funds from day one. A HELOC likely makes more sense simply because you won’t pay interest on any portion of your funds that you don’t use.
Do you know exactly how much money you need?
If you’ve got a one-time upcoming expense that you need to cover, a standard home equity loan may be your best option. It dumps a large sum of money into your account upfront, giving you predictable monthly payments that are helpful for budgeting.
Are mortgage rates considerably lower than when you first took out a mortgage?
If today’s mortgage rates are, say, more than a percentage point below what they were when you opened your current home loan, it could be a good time to refinance your mortgage. A cash-out refinance can be the perfect solution for those who need a large sum of money to fund a project.
Would you like to loosen up your budget during your retirement years?
Perhaps you don’t have a specific big-ticket initiative but instead live on a fixed income that you find difficult to manage. This is a fairly common situation later in life.
A reverse mortgage may be just the solution you need, as you’ll generally stop making mortgage payments and can elect to receive monthly payouts from your equity to subsidize your expenses. Again, that loan balance grows over time and will need repaid when the house is either sold or inherited.
Requirements to borrow from your home equity
The requirements to borrow home equity are in some ways similar to a traditional personal loan. For example:
- Credit profile: Home equity loans, lines of credit, and cash-out refinances require a solid credit score to achieve the best interest rates. This means low credit utilization (experts recommend 30% or less), a long history of on-time payments, and a lengthy average age of accounts.
- Debt-to-income ratio (DTI): Your DTI is the percentage of your monthly income tied up in making the minimum payment on your current debts. Lenders generally prefer a DTI of 45% or less.
- Income and employment: You’ll have a tough time getting any type of loan if you don’t have an income that the bank considers sufficient to pay the money back. It’s also best to have several months of stable employment in the rearview mirror to demonstrate that your income is reliable.
You’ll also need a minimum amount of equity before you can borrow. Depending on the lender, you’ll generally be required to keep between 15% and 20% equity in your home at all times. In other words, you likely won’t be allowed to borrow if you’ve only built 10% equity.
Fees associated with borrowing from your home equity
In all instances but a home equity investment, there are closing costs associated with accessing your home’s equity. Some lenders advertise waived fees, but you can generally expect to pay things like:
- Origination fee
- Appraisal fee
- Title search fee
- Document preparation fee
- Notary fee
Closing costs regularly amount to between 2% and 5% of your total loan price.
Alternatives to borrowing from your home equity
Accessing your home equity is far from the only option when you need to fund a large purchase or ongoing project. Below are few other popular options with their advantages:
- Personal loan: This unsecured loan comes with less strings than a home equity loan. If you’re unable to make your payments, the lender won’t take your property. But they’re often capped at lower potential borrowing amounts than a home equity loan. You’ll receive an upfront lump sum deposited into your bank account and you’ll be enrolled in equal monthly payments until your loan principal and interest is paid.
- Personal line of credit: Similar to a HELOC, a personal line of credit gives you a revolving credit limit with which you can spend during a draw period and pay back during the repayment period. This, too, is an unsecured loan—meaning the bank won’t take your property if you default on your loan.
- Credit card: This is often a less savvy method of funding a large purchase due to the typically high APR. However, some credit cards come with 0% intro APR for a year or nearly two upon account opening. If you can pay off your balance before that interest-free window ends, this could be the cheapest way to finance your expense.
Alternatively, you may choose to borrow money from loved ones to avoid incurring interest and formal credit checks. But make sure you have a frank conversation about expectations to avoid damaging the relationship.
The takeaway
There are five common ways to access your home’s equity: a home equity loan, a home equity line of credit, a cash-out refinance, a reverse mortgage, and a home equity investment. Each has its own unique upsides depending on your financial goals.
Frequently asked questions
What are the risks of using your home as collateral when you access its equity?
When you use your home as collateral, you run the risk of losing your property if you default on your loan. The bank can sell your house to recoup its losses.
How can you use a home equity loan to turn equity into a lump sum of cash?
The way a home equity loan is fulfilled is with a lump sum of cash into your bank account. When you take out your loan, the bank will deposit the funds all at once into your account and enroll you in monthly installments until the loan is repaid.
What credit score and debt‑to‑income ratio do you typically need to borrow against your home equity?
Depending on the lender, you will likely need a credit score between 620 and 680 to access your equity. You’ll also often need a debt-to-income ratio of 45% or less.
How do you safely use home equity to consolidate high‑interest credit card or personal loan debt?
Using your home equity to consolidate high-interest debt can be a great idea. But to do it safely, you should be sure that your spending habits have changed. If they haven’t, you could find yourself in far worse debt in the future—and even lose your home.
Can you access home equity if you’ve owned your home for only a few years and have limited equity?
You can access your home equity even if you’ve only owned the home for a few years. However, most lenders require you to keep between 15% and 20% equity in your home at all times. If you’ve got less than that, you won’t be able to borrow.
