What Is Home Equity And How Can I Access It?

If you use a mortgage to help purchase a home, it will take years of paying off the loan before you own the home outright. However, as you pay it back, you increase the percentage of your home that you do own. That’s where home equity comes in.

The portion of your home that you own is known as home equity. Equity can be a powerful financial tool that you can use to pay off debt, renovate your home or make other financially savvy decisions.

What Is Home Equity?

Home equity is the amount of your home that you actually own. Specifically, equity is the difference between what your home is worth and what you owe your lender. As you make payments on your mortgage, you reduce your principal – the balance of your loan – and you build equity. Once you have enough equity built up, you can access it by taking out a home equity loan or home equity line of credit (HELOC), or by using a cash-out refinance.

If you still owe money on your mortgage, you only own the percentage of your home that you’ve paid off. Your mortgage lender owns the rest until you pay off your loan.

How Does Equity Work?

When you purchase a home, the down payment you make instantly becomes your equity stake in the home. For example, if you make a 5% down payment, your starting equity is 5%. If you make a larger down payment, your equity percentage is higher.

As you pay back the loan, the balance on your loan decreases and your equity increases. Every payment you make slightly increases your equity.

How To Calculate Your Home Equity

To calculate your equity, determine how much you still need to pay on your mortgage principal. Your lender will be able to tell you the balance of your loan.

Next, estimate how much your home is worth. To do this, look at the sale prices of similar homes that have sold near you.

To do the calculation, simply subtract your loan balance from your estimated home value.

For example, say you owe $100,000 on your home, and you estimate your home to be worth $180,000. Simply subtract $100,000 from $180,000. You have an estimated $80,000 in home equity.

If you’re thinking about refinancing, it’s important to know that lenders usually require a home appraisal to determine the home’s value and the amount of equity you have. Estimating your home value can give you a rough idea of how much equity you have, but an appraisal is the only way to know for sure.

How Can You Use Your Home Equity? 4 Common Ways

There are very few restrictions on how you can use your home equity. That said, here are some of the most common and useful ways people use it.

1. Remove Private Mortgage Insurance (PMI)

Though you no longer need a 20% down payment to buy a home with a conventional loan, most lenders require you to purchase PMI if you don’t put at least 20% down. Even though the borrower pays for it, PMI only protects the lender. Most homeowners prefer to cancel PMI as soon as possible.

If you have a conventional loan, PMI is automatically canceled once you reach 22% equity in your home, according to your regular payment schedule. However, you can request that your lender cancel PMI once you’ve reached 20% equity in your home.

2. Make Home Improvements

Do you want to renovate your home but don’t have the cash on hand? You can pay for home improvements by refinancing your mortgage. When you finance your renovations using the equity in your home, you’ll be paying for the renovations at a much lower interest rate than if you were paying for them with a credit card or personal loan.

3. Pay For College Tuition

College can be expensive, and student loans aren’t always the lowest-interest way to cover tuition and room and board. You can use your home equity to get cash for tuition or to consolidate your existing student loans into a single, lower-interest loan.

4. Consolidate High-Interest Debts

Mortgage refinance and home equity loan interest rates are typically much lower than interest rates for credit cards, auto loans and personal loans. If you have any of these high-interest debts, you can save big by putting your home’s equity to work.

There are a couple of benefits to using your home equity for debt consolidation:

• Consolidating debt simplifies your payments. By paying off your bills with cash from your home, you’ll bundle your debt payments into a single, lump-sum loan.
• You’ll save big on interest. Interest rates for credit cards and personal loans commonly exceed 10%, while mortgage refinance and home equity loan interest rates are usually significantly lower.

How Can You Access Your Home Equity?

You can get access to your home equity through a cash-out refinance, a home equity loan, a HELOC or a reverse mortgage.

Cash-Out Refinance

A cash-out refinance allows you to take out your equity by getting a new mortgage at a higher loan amount. You replace your current mortgage with a bigger one and get the difference in cash. Like any refinance, your new mortgage pays off your old one, so you just have one monthly mortgage payment. It generally takes between 30 and 45 days to refinance.

When you do a cash-out refinance, you usually need to leave some equity in the home. The amount you’ll have to leave depends on the type of loan you’re seeking, but you should expect to leave about 20% equity in the home.

Home Equity Loan

A home equity loan is a second mortgage on your home. It doesn’t replace your current mortgage; it’s a second mortgage that requires a separate payment. For this reason, home equity loans tend to have higher interest rates than first mortgages.

Like a cash-out refinance, a home equity loan is a secured loan that uses your home equity as collateral. This gives you access to lower interest rates than unsecured loans, like personal loans.

Once you close on your home equity loan, you’ll receive a lump-sum payment from your lender, and in return, you’ll make payments on the loan over a predefined term.

Lenders rarely allow you to borrow 100% of your home’s equity for a home equity loan. The maximum amount you can borrow will vary by lender but it’s typically between 80% and 90% of the value of the home. Rocket Mortgage^® is now offering home equity loans, which are available for primary and secondary homes.

Home Equity Line Of Credit (HELOC)

A HELOC is also a second mortgage on your home. The main difference is that a HELOC gives you a line of credit you can draw from when you need it. The credit limit corresponds to the amount of equity you have in your home.

You can withdraw money from your HELOC at any time during the draw period defined by your lender. Most draw periods are between 5 and 15 years. HELOCs may have a minimum monthly payment due (similar to a credit card), or you may need to pay off the accrued interest each month. At the end of the draw period, you’ll need to repay the full amount you borrowed.

Rocket Mortgage does not offer HELOCs at this time.

Reverse Mortgage

If you’re over the age of 62 and would like to boost your retirement savings, you may want to consider a reverse mortgage. There’s no monthly mortgage payment with a reverse mortgage, though you must still pay taxes and insurance.

With a reverse mortgage, your loan amount is based on the amount of equity you have in your home. If you have an existing mortgage, the proceeds of the loan are used to pay it off. The remaining balance is available for you to use as you see fit.

A reverse mortgage can be a good choice for homeowners who plan to stay in their home indefinitely and aren’t worried about leaving an inheritance. It can give you cash in retirement if you don’t have anywhere else to get it.

Rocket Mortgage does not offer reverse mortgages at this time.

How To Increase Your Home Equity

There are three ways you can increase your home equity: You can pay down your principal, wait for your home value to rise or make renovations or upgrades.

Pay Down Your Principal

Every time you make a mortgage payment, you gain a little more equity in your home. At the very beginning of your mortgage repayment, you gain equity slowly because most of the money you pay in the first few years goes toward interest instead of your mortgage’s principal.

As you pay down your balance, a higher portion of your monthly payment goes toward the principal balance instead of interest. This process, called mortgage amortization, helps you build equity faster toward the end of your loan term.

If you want to build equity faster in the first few years of your mortgage, you can pay more than your minimum monthly payment. Just tell your lender that the extra money should be applied to your principal.

Wait For Your Home Value To Rise

Equity is based on the appraised value of your home. The equity you have is equal to how much an appraiser believes your home is worth, minus the balance of your loan. For example, let’s say you bought a $250,000 home with a $200,000 mortgage. A few years later, your home appraises for $300,000 because the housing market is hot. If you’d paid the loan down to $150,000, you’d have $150,000 in home equity.

Unfortunately, this process also works in reverse. If your local housing market takes a turn for the worse and the value of your property decreases, your equity decreases as well. The amount you’d owe on your mortgage wouldn’t change, but your equity in the property would.

Make Renovations Or Upgrades

Another common way homeowners can increase their home equity is by making renovations to their home. These renovations could be anything from building a larger living room or bedroom to adding a bathroom. Various upgrades to a home can also boost equity, like upgrading kitchen countertops or flooring and adding new sinks and showers in bathrooms. The higher the quality of the home, the more it could sell for on the real estate market.

However, some home renovations can become costly, so make sure you understand how much your renovation will cost to make this construction worth your while.

Is Using Your Home Equity A Good Idea?

Using the equity in your home can be a great way to cover expenses or consolidate higher-interest debt. However, it’s not something you should enter into lightly. You should weigh the pros and cons before you take out a loan.

Pros

• Lower interest rates: Home equity loans, lines of credit and cash-out refinances typically have lower interest rates than credit cards and personal loans. This means you’ll pay less in interest and may save thousands of dollars.
• No restrictions on use: When using your home equity, you can use the money to cover whatever expenses you deem necessary.
• Some tax benefits: If you’re using the money to help cover the cost of home repairs or home improvements, you may be able to deduct a portion of the interest you pay on your taxes. This can reduce how much you’ll owe the IRS at the end of the year.

Cons

• Puts your home at risk: Home equity loans, lines of credit and cash-out refinances are secured by your home. If you fail to make payments on time or default, you risk losing your home.
• May give you an extra monthly payment: Unless you’re using a cash-out refinance, you’ll end up with two payments due every month. This can make it harder to stay on top of your finances.
• Required closing costs: You typically pay closing costs when you take out a home equity loan, HELOC or cash-out refinance. The closing costs generally range from 3% – 6% of the loan’s principal, which could cost you thousands upfront.

The Bottom Line: Home Equity Is A Valuable Tool

Your savings and retirement accounts aren’t necessarily your only assets. Your home is one of your biggest assets with equity you can access and use.

For homeowners who are looking for a low-interest way to borrow against their home, cash-out refinancing is often a good choice. However, you should make sure you can make the minimum monthly payments on your loan before you close.

Ready to access your home equity with a cash-out refinance? Get started on the refinance process today.