Options to Unlock Your Home Equity When Finances Are Tight

What is home equity?

“Home equity is the value of your home minus any debt on your home,” explains Lawson.

So, if you own a home that’s estimated to be worth $300,000 and owe $100,000 on your mortgage, then your equity is $200,000.

Since your home’s value changes with the market, your home might be worth more or less than the price you paid. By using HomeLight’s free online Home Value Estimator, you can generate an up-to-date approximation of your home’s current value in less than two minutes.

While a mortgage is the most common debt, liens (legal claims against the property), back taxes, and outstanding balances owed to other creditors can also reduce your equity.

Moreover, “If you want to gain access to your equity by selling the home,” Lawson adds, “there are additional expenses related to the transaction of a sale. Realtor commissions and closing costs […] need to be deducted from your equity estimate.”

Can I get the equity out of my home without selling it?

You don’t have to sell your home to unlock your equity. If you meet eligibility requirements, many banks, credit unions, and other financial institutions have loans that allow homeowners to convert part of their equity to cash.

You can use that money for anything: debt consolidation, tuition, home renovation, or a dream vacation. However, those funds aren’t exactly mad money because you have to pay the amount back with interest. Plus, removing the equity from your portfolio of assets does come with certain risks. So, it’s in your best interest to leverage your equity’s power to improve your financial future.

While some lenders have customized loans for home renovation or other projects, the most common types of equity loans are cash-out refinance and second mortgages, which include a home equity loan or a home equity line of credit (HELOC).

Since all these loans use your equity in the home as collateral, they usually offer significantly lower interest rates and better terms than personal loans, credit cards, and other unsecured debt.

What qualifications do I have to meet to access my home’s equity?

Before you weigh your options, it’s best to determine if you qualify. Banks, credit unions, and other lenders each have their own criteria. But according to James Nedved, vice president and mortgage production manager at Regions Bank in Orlando, Florida, homeowners are likely to qualify for home equity loans if they have:

• Owned the home for a year or long enough to build sufficient equity
• Made mortgage and other payments on time, and
• Maintained a credit score of at least 620.

What are the differences between a cash-out refinance and a secondary mortgage?

When you’re looking for ways to tap into your home’s value, there are several options to consider depending on your financial goals. Two of the most common are a cash-out refinance and a secondary mortgage, both of which let you access your equity in different ways.

Distinguishing loan types, Nedved explains, “A cash-out refinance is a mortgage transaction, [while] secondary mortgages, [such as] home equity loans and HELOCs, are consumer transactions, so they are governed by a different set of rules.”

He notes how secondary mortgages are typically priced, explaining, “Because secondary mortgages are shorter-term loans than a cash-out mortgage, they are tied more to prime rate [similar to credit card rates, which are usually prime plus a percentage] than a mortgage is.”

In other words, HELOCs and home equity loans often move with the prime rate because of their loan structure.

Meanwhile, explaining the pricing of cash-out refinancing, Nedved shares, “Many times, cash-out transactions are at a higher rate because you are taking equity out of your home.”

By contrast, second mortgages leave the first mortgage intact, which could save the homeowner money in the long run. Particularly if the homeowners bought the home in the last two years, “That pricing is a lot better than we can get today,” says Nedved.

Furthermore, Nedved says many banking institutions usually absorb the closing costs of home equity loans and HELOCs up to $250,000. Often, homeowners are only responsible for paying the cost of an appraisal. However, secondary mortgages don’t work for everyone since every situation is different.

As a primary mortgage loan, the cash-out refinance tends to be repaid over a longer time period, so the amount of each monthly payment may be smaller than that of second mortgage options. With the ongoing inflation, a smaller monthly outlay may be easier on the family budget.

How does a cash-out refinance work?

In a cash-out refinance transaction, you take out a new, larger mortgage and use the difference between your old loan and the new one as cash. You can take the equity out of your home, which is subject to current interest rates, and access funds for things like renovations, debt repayment, or emergency expenses.

The monthly payment on their new fixed-rate loan is based on the current interest rate and the new loan amount. Term lengths can vary.

Those who choose cash-out refinance can roll closing costs into their new mortgage by bumping up the loan amount or covering them with the proceeds from a cash-out refinance. Either way, the costs get bundled into the overall loan balance, meaning they’re repaid over time instead of upfront.

Whether the funds are taken all at once or accessed gradually, the borrower still repays the full amount with interest through their monthly payments.

“You’re probably not seeing too many cash-out refinances right now,” says Lawson. “That’s because interest rates have gone up so significantly over the last six months.”

For example, it might not make sense for homeowners whose existing mortgage rate is 3.5% to refinance a large portion of the original loan plus additional funds at 6%. Other options might be more attractive.

How does a home equity loan work?

A home equity loan lets a homeowner borrow a lump sum of money by using the equity they’ve built in their home as collateral. The amount they can borrow is typically based on the difference between what the home is worth and what’s still owed on the mortgage.

Once approved, the borrower receives the funds upfront and can use them for things like renovations, debt consolidation, or major expenses. The loan is then repaid in fixed monthly payments over a set term, often with a fixed interest rate that stays the same throughout the life of the loan.

This makes payments predictable and easier to budget for compared to variable-rate options. Because the home is used as security for the loan, falling behind on payments can put the property at risk of foreclosure.

A second mortgage usually carries a higher interest rate than first mortgage rates nationwide. That’s because, in the case of foreclosure, the first mortgage lender will need to be paid in full from the proceeds of the home sale before the second mortgage lender can be paid.

Because a home equity loan is an installment loan, borrowers receive all the funds upfront and pay back principal and interest on a pre-set schedule, usually over five to 15 years.

How does HELOC work?

Another type of second mortgage is a HELOC, which also lets homeowners tap into the equity they’ve built in their home. Unlike a home equity loan, it works more like a revolving credit line, where you can borrow, repay, and borrow again during the draw period.

One of its main advantages is flexibility. You only use what you need, when you need it, instead of taking a lump sum upfront. This can help keep interest costs lower since you’re not charged on the full amount at once. HELOCs also often come with variable rates tied to the prime rate, which can be beneficial when rates are low.

Those who use HELOC do not repay principal and interest immediately. “And, you don’t pay anything on it, unless you draw from it,” Lawson explains.

However, when the draw-down period ends, even if they haven’t withdrawn the entire amount, they are ineligible to borrow any more money.

During the repayment phase, the borrowers typically have 10 to 20 years to repay any outstanding balance.

Because the interest-only payments made during the draw-down can be pretty modest, some homeowners suffer from sticker shock in the repayment phase. So, borrowers need to plan for those higher payments and the potential impact on the family budget.

Even if they don’t need cash right away, many homeowners proactively set up a HELOC as a rainy-day emergency fund.

“If you have a family emergency, want to renovate your home, need to make a large purchase, or access a large amount of money quickly,” Lawson says, “having that vehicle set up gives you the availability of that capital.”

Can I use my home equity to buy a home before I sell?

Unlocking home equity isn’t just for paying off debt, fixing up your home, or covering emergencies. You can also use it to buy your next place before you sell your current one. That can take a lot of pressure off, since you’re not trying to line up two big transactions at the same time or rush into decisions.

While people often think of options like a second mortgage or cash-out refinance, those aren’t the only ways to tap into your equity. There are also “Buy Before You Sell” programs that help bridge the gap. HomeLight’s Buy Before You Sell program, for example, lets you access your equity so you can move forward on a new home without waiting for your current one to sell first.

Here’s how it works: they look at your current home using a data-based model to estimate how much equity you can tap. You can then use that money for your down payment, moving costs, closing fees, or even repairs on the new place. The big win is that it lets you make offers without a home sale contingency, which can make your offer stronger in competitive markets.

Watch the video below to learn more about HomeLight’s Buy Before You Sell program:

How do I know which home equity option is best for me?

“I have those conversations on a regular basis, and there isn’t a one-size-fits-all solution,” Nedved says. “We move towards the least costly option first, and if that doesn’t work, we aim for the best solution long term.”

For example, if the homeowners just want to add a pool, a HELOC might be the best option, Nedved shares.

If the homeowners’ first mortgage is at an amazingly low rate and they value the predictability of an installment plan, a traditional home equity loan might be the right choice, according to Nedved. If it’s a debt situation in which the family needs to have the lowest payment possible because the homeowner is on a fixed income, a full cash-out refinance might be more beneficial.

However, “The best option depends on a whole host of parameters that are specific to the client’s situation and what the total family budget looks like,” Nedved says. “That’s why it’s important to work with a trusted mortgage or consumer lending advisor.”

What are the pros of pursuing a home equity loan?

“Most people don’t have access to thousands of dollars in cash,” says Lawson. “So, the primary advantage of using your home equity is access to a large amount of capital in a short amount of time.”

Other advantages of taking equity out of your home can include:

• Lower interest rate than personal loans or credit cards
• Fewer fees than some loans
• More flexibility in repayment options
• Fewer borrowing restrictions

What are the cons of cashing out home equity?

While unlocking your home equity provides financial relief, seeking a second mortgage or cash-out refinance is not without risk. The less equity you have in your property, the higher your overall debt.

“So, if you were to lose your job, if a recession hits, if you come into harder financial times and you’re more highly leveraged on your property,” Lawson explains, “that’s a [riskier] situation to be in, with higher monthly payments and more uncertainty with your employment.”

For some homeowners, that scenario also brings back bad memories from the 2008 housing crisis. When home values plummeted, some homeowners realized they had maxed out their loan equity and had no financial reserves to draw on in an emergency.

“That doesn’t appear to be the case today,” says Nedved, who has been in the mortgage business for almost three decades, “But, that’s not an absolute. There’s always that risk.”

Other drawbacks of taking equity out of your home can include:

• Risky use of your home as collateral
• Serious possibility of foreclosure and potential loss of housing if payments are missed
• Uncertain impact from declining home values

As a Realtor with over 15 years of experience, Lawson offers another perspective. “It’s kind of a pro and a con built into one,” he admits.

“People are concerned about the interest rates increasing so dramatically,” he begins. “But even rates at 5.5% and 6% are still historically low. So, even at those rates, home equity loans are still a great way to tap into a lot of capital.”

Who can I rely on to help make this decision?

Whether to access the equity in your home is not a decision to be made lightly. Fortunately, it doesn’t have to be made alone.

Both Lawson and Nedved advise collecting the appropriate documents, conducting your research, consulting with your family co-signers, and seeking out the expertise of some or all of these professionals, including a/an:

What should homeowners have before seeking professional advice?

Before visiting the mortgage or consumer loan professional, it’s important to collect and present financial documentation, including:

• Last two years of W2s (or other appropriate evidence of income)
• Last three pay stubs
• Current mortgage statement

Some lenders may require a more extensive list of documentation, but these three are a good place to start. Nedved says The Big Three (above) and your credit score provide lenders with an accurate estimation of what you currently owe and how much additional debt you can afford.

Another essential element of a strong loan application is an honest conversation at home between adults applying for a loan together.

“If they can agree on where they are now and what their financial goals are, the mortgage lender can do a better job of navigating them towards their goal.”

Here's How You Can Buy Before You Sell

With HomeLight Buy Before You Sell, you can make a strong, non-contingent offer on your new home without waiting to sell your current home. This modern bridge solution unlocks the equity in your existing property, streamlining the entire process so you win the home you want and move only once.

Learn more

No need to wait for dire economic straits

You don’t have to wait for a financial emergency to start looking into how your home equity could improve your financial future.

By using HomeLight’s Home Value Estimator, you can quickly and easily approximate the value of your home and then deduct what you owe to determine your ballpark equity.

Using your equity to pay off high-interest debt, tackle home renovations, or even buy another property can be a smart move. A HELOC might offer peace of mind by giving you flexible access to funds while keeping your current mortgage intact.

For others, a home equity loan may provide a more cost-efficient path, or the longer repayment term of a cash-out refinance might better suit the family budget. In the end, you might also decide that the best choice is to leave your equity untouched, for now.

Editor’s note: This blog post is for educational purposes only, not legal or tax advice. Reach out to your own advisor for professional guidance on unlocking your home’s equity.

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