How To Get Equity Out Of Your Home: A Guide for Homeowners

You’ve heard it a thousand times: “A home is a great investment!” On paper, that’s often true. But how do you take advantage of this appreciating investment and get to this money when you need it? The answer is to access the home’s equity — or essentially, the percentage of the home that you own. But how do you get equity out of your home?

There are different ways to access these funds, which we’ll explore below. But it’s important to be judicious about getting equity out of your home, because failing to make the required payments could result in foreclosure or create serious damage to your credit rating — among other possible negative impacts. 

There are a few ways to get equity out of your home, including through a cash-out refinance, a home equity line of credit (HELOC) and a home equity loan. By tapping into your home’s equity, you can access funds without having to sell your home in order to collect the money from the sale.

Understanding Home Equity

To understand home equity, you must understand the fundamental economics of home ownership (don’t worry — it’s not that complicated). An example might work best: Let’s say you buy a home for $250,000, and its value rises to $275,000 (based on condition of the house, the real estate market, etc.).

Over the course of several years, you pay off the principal of your mortgage to the point where you owe $200,000. Congratulations — you officially have $75,000 in equity on your home.

You build equity by making your mortgage payments, which increases your percentage of ownership. You also increase your equity if your home’s value increases — unfortunately, the converse is also true, and your equity decreases if your home’s value drops.

How to Calculate the Equity in Your Home

If you want to determine your home equity, first find your home’s value then subtract how much remains on your mortgage principal. That difference is the amount of equity you have in your home.

Home equity, however, is often stated as a percentage. So, let’s use our previous example of someone whose equity is $75,000 on a $275,000 home. You would take the amount of equity, $75,000, and divide it by the value of the home, $275,000. That means you have 27.2% equity.

Three Ways to Access Home Equity

Sometimes, you may want to let home’s equity increase and only take advantage of it when you sell the property. But other times, you may want to access those funds for repairs, loan consolidation, or other costs, which means you’ll need to know how to pull equity out of your home.

There are three main ways to access your home’s equity: a cash-out refinance, a home equity line of credit (HELOC) and a home equity loan. (Note: These are the most popular methods of accessing your home’s equity, but not the only ones.)

Cash-Out Refinance

When you do a cash-out refinance, you essentially sign up for a bigger mortgage loan that pays off your existing mortgage and convert some of the equity you've built up in your home into cash. Basically, you're increasing your mortgage debt, but taking advantage of a lump sum you can use for things like home renovations or paying off other higher-interest debts.

Something to keep in mind is that there is typically a limit on how much you can withdraw using this method. Most lenders, for instance, have a ceiling of 80% equity. (An exception to that rule is for VA loans, which can allow a loan of up to 100% equity if you have a qualifying credit score.)

Pros and Cons of a Cash-Out Refinance

A cash-out refinance has benefits, but it also comes with drawbacks. Here are some of both:

Home Equity Line of Credit (HELOC)

If you have amassed enough equity, you can access it by creating a home equity line of credit (HELOC).

A HELOC essentially acts as a revolving line of credit (similar to a credit card), which means the amount you borrow fluctuates as little or as much as you need — up to your approved credit line. Also, you only have to pay interest on the amount that you borrow during the initial draw period, which typically is the first 10 years of the HELOC.

Pros and Cons of a HELOC

Taking out a HELOC has both positive and negative effects:

Home Equity Loan

When you take out a home equity loan, you’re using your home as collateral in a lump sum loan. In other words, it’s a second mortgage that’s taken out on top of your first mortgage.

Pros and Cons of a Home Equity Loan

A home equity loan has many positive benefits, but it also comes with drawbacks. Here are the pros and the cons:

Which Home Equity Option Works Best for You?

To determine the best home equity option, it’s critical that you establish what you need the money for in the first place.

• Lump-sum expenses: If you need a lot of money for one large project, you might want to consider a cash-out refinance or home equity loan because the payment comes in one check. This allows you to use the funds for the project at-hand.
• Home improvements: If you are doing a substantial amount of work on your home, like putting on an addition or finishing a basement, you might want to consider a cash-out refinance or a home equity loan.
• Debt consolidation: If you’re seeking to consolidate your debts, consider any of the three ways above. These methods of accessing your equity often have a lower interest rate than personal loans.
• Emergency fund: If you’re looking to create an emergency fund, you should consider a cash-out refinance or home equity loan, which can be paid out in one lump sum and have reasonable interest rates.

The Bottom Line

One of the benefits of owning a home is that it usually appreciates in value — but to access those funds while you live there, you need to get to its equity. Cash-out refinances, HELOCs and home equity loans let you use that equity, but all come with certain advantages and disadvantages. Which option works best for you depends on your specific financial situation and what you need the money for.

To develop a good handle on your money and see which plan would work best for you, download the Rocket Money℠ app. This will help you keep a close eye on your financial health and determine whether you’re a good candidate for a HELOC, cash-out refinance or home equity loan.