People sometimes talk about home equity – the difference between your home’s value and what you still owe on it – like it’s a stack of cash just waiting to be used. But accessing your equity usually means borrowing against it, and that always involves some level of risk.
The key to making smart choices with home equity is to understand your options and choose the one that best fits your financial goals. Below are three common ways to tap into your home’s equity, with tips to help you decide the right move for you.
- Home equity loan
A home equity loan allows you to borrow a lump sum using your home as collateral. You pay off the loan in fixed monthly installments over a set period.
These loans typically have fixed interest rates, so your monthly payments stay the same throughout the life of the loan. That kind of predictability can be a big plus, mainly because falling behind on payments could eventually lead to foreclosure.
Another risk? If home values drop after you get the loan, you could end up owing more than your house is worth, a situation described as “being underwater.” That can make it harder to sell, refinance, or qualify for additional credit in the future.
When is a home equity loan a good choice?
A home equity loan may be a good fit if you need to cover a one-time, fixed cost – especially if the situation is urgent, like replacing your roof or funding a major repair.
- Home equity line of credit (HELOC)
A HELOC is a revolving line of credit that typically has a variable interest rate. It works a bit like a credit card: You’re approved for a maximum amount, and as you repay what you borrow, the available balance is replenished. You only pay interest on what you borrow.
Most HELOCs come with a draw period, usually lasting five to 10 years, where you’re only required to pay the interest. After that, the repayment period begins. You can no longer borrow money, and you start paying both the principal and interest.
That flexibility can be useful, but it also creates some risks:
- Your monthly payments feel manageable, but you’re not reducing the amount you owe.
- You will likely see a big jump in your monthly bill when the repayment period starts.
- The draw period can make it easy to treat the line of credit as extra cash for everyday spending, which can lead to overborrowing.
Long story short? Without a solid plan, you risk borrowing more than you can repay or being underwater.
When is a HELOC a good choice?
HELOCs may be right for ongoing or unpredictable costs. For example, home renovations can have contractor delays and last-minute changes. Using a HELOC to fund them gives you the flexibility to borrow as needed.
- Cash-out refinance
A cash-out refinance replaces your current mortgage with a new, larger loan. The new loan pays off your mortgage, and you get the difference in cash.
Depending on how much equity you have in your home, cash-out refinancing may give you access to a large sum of money that you can use for various purposes. And if you switch when mortgage rates are low, you may save money in the long run.
However, there are trade-offs. A cash-out refinance requires balancing:
- A monthly payment you can afford.
- A loan term that fits your goals.
- The interest rate you qualify for.
For example, refinancing into a shorter-term loan typically means higher monthly payments, but less interest paid overall. Extending your loan term does the opposite: lower monthly payments, but more interest over time.
And don’t forget the risk: You’re increasing your loan balance, which may stretch your budget and make it difficult to keep up with your payments.
When is a cash-out refi a good choice?
Cash-out refinancing is often used to pay off high-interest debt, like credit cards and personal loans. But this move only makes sense if you qualify for a significantly lower interest rate and you have a plan to avoid taking on more debt. Otherwise, you’re only spreading that debt out over a longer period – and securing it with your home.
Make your home equity work for you
Home equity is a valuable asset, so tapping into it should be thoughtful, not rushed. Review your options carefully, match the method to your goals, and avoid borrowing more than you're ready to manage. With the right strategy, your home equity can be a powerful tool that supports your financial future.
Sources
http://experian.com/blogs/ask-experian/pros-and-cons-home-equity-loan/
https://www.experian.com/blogs/ask-experian/heloc-pros-cons/
https://www.experian.com/blogs/ask-experian/pros-and-cons-of-cash-out-refinance/
https://files.consumerfinance.gov/f/documents/cfpb_jith-using-home-equity-guide.pdf
