3 Ways to Tap into the Money in Your House

Written By: Ella Taylor

August 26, 2022

Have you ever wondered exactly HOW to tap into the money in your home? If you’ve been feeling a bit cash-strapped or if you simply want to know how to tap into your home equity should the need arise, keep reading.

WHAT IS HOME EQUITY?

Home equity is the portion of your home that you've paid off. It's the difference between what the home is worth and how much you still owe on your mortgage. For many people, equity from homeownership is a key way to build personal wealth over time because as your home's value increases over the long term, and you pay down the principal on the mortgage, your equity grows. 

WHY USE HOME EQUITY?

Equity provides many opportunities to homeowners, because it's a great source for savings and for financing. For example, the equity amassed in a starter home can be tapped into and later provide the down payment needed to purchase a larger home as a family grows and needs more space. Tapping your home equity can be a convenient, low-cost way to borrow large sums and often represents a more cost-effective financing options than credit cards or personal loans with high interest rates. However, the right type of loan depends on your needs and what you plan to use the money for. 

There are three main strategies for unlocking your home's equity and these are:

1. Cash-out refinancing

2. Home Equity Line of Credit

3. Home Equity Loan

To tap into your home's equity via one of these strategies, you'll need to go through a process similar to obtaining a mortgage. You can apply through a bank, credit union, online lender or another financial institution that offers these home equity products.

But before you make a decision, you need to be aware of the implications, as you'll be increasing your debt load while decreasing your home equity. It's advised that you use the money for purposes that really add value. However, what one person may consider valuable, another person may consider frivolous. Therefore, it's up to each individual homeowner to determine whether or not tapping into their home equity is the right decision.

If pulling cash out of your home makes sense, you're going to want to weigh these three options. Here's what you need to know about these borrowing strategies.

CASH-OUT REFINANCING

In a cash-out refinance, you refinance your primary mortgage for more than what you currently owe, then pocket the difference in cash. (Not to be confused with the standard mortgage refinance, which involves obtaining a lower interest rate while keeping your mortgage balance the same as it was before). This method of tapping into your home equity generally provides the best option for pulling out a large amount of cash.

So let's break this down so you understand exactly how this works:

Let's say your home is worth $300,000 and you currently owe $200,000 on your mortgage. That gives you $100,000 in home equity. This means you can borrow $80,000 because mortgage lenders normally let you borrow up to 80 percent of your home equity. For the purposes of this example, let's say you want to pull out $50,000.

To get this money, you will need to take out a new mortgage for $250,000 ($200k in mortgage owed and the $50,000 you want to borrow) and receive a $50,000 check at closing. You'll also pay closing costs, which range from about 3 percent to 6 percent of the loan amount - that's $7,500 - $15,000 for a $250,000 loan. (Closing costs can be paid upfront, or they can be rolled into your new mortgage). 

To qualify for a cash-out refi, lenders look at your debt-to-income (DTI) ratio which is how much money you owe each month in financial obligations such as credit card payments or mortgage loans divided by your monthly income. Generally that ratio cannot exceed 36 percent of your gross monthly income. 

HOME EQUITY LINE OF CREDIT

With a home equity line of credit, or HELOC, you have access to a source of funds that pretty much acts like a credit card. Most mortgage lenders will even issue you a HELOC card, a lot like a credit card, giving you easy access to the money. With a HELOC you have the ability to take out multiple loans within the "draw period". A HELOC draw period is the part of a HELOC where you can withdraw and use the funds from your line of credit.

If you're taking out a small amount of money, let's say $10,000 to $20,000, the HELOC might make more sense, especially if you currently have a really great rate on your first mortgage. And the reason why is because you would likely have to re-finance at a higher rate if you do a cash-out refi instead.

You can generally borrow 75 to 80 percent of your homes appraised value. (Some lenders 

go as as high as 90%). After the draw period--typically 10-20 years-any outstanding balance will need to be paid back. The interest rate for a HELOC is typically variable (interest rates may go up or down as market interest rates change) and higher than that of a cash-out refinance--recently the average was 8.54 percent  according to Bankrate.com. HELOC's are determined by your financial situation and your credit score. If you have good credit, your HELOC rate could be around 3 percent to 5 percent. If you have below-average credit, you'll likely fall within the 9 percent to 10 percent range.

Normally there aren't any closing costs for a HELOC, but you may be charged an appraisal fee (usually $300 to $400) and an annual fee of about $100 or less. Underwriting and eligibility requirements are less complicated for borrowers of the HELOC than they are for cash-out refinances. Regardless whether or not you need cash right away, it makes sense to set up a HELOC as a stand-by emergency fund.

If you're looking to spend as you go and only pay for what you've borrowed, when you've borrowed it, a HELOC is probably the best option.

HOME EQUITY LOAN

Of all the strategies, the home equity loan (often referred to as a second mortgage) is the most straight forward. The way it works is that you borrow against the value of your house, and receive a lump sum of money upfront, which you begin repaying with interest immediately. A home equity loan's interest rate is fixed, meaning that the rate doesn't change over the years. The recent home equity loan rate is 6.96%.

You're able to borrow 80-85 percent of your home's appraised value, minus what you owe. Closing costs for a home equity loan typically range from 2 to 5 percent of the loan amount - that's $5,000 to $12,000 on a $250,000 loan.

So if you know exactly how much money you need and you're seeking a fixed interest rate, a home equity loan can be a great option.

The beauty of home equity loan is their flexibility. Since they are paid in a lump sum and rapid over time, they can be used for any purpose-including buying a vacation home. So if you're looking for a fixed monthly payment and a large sum of cash up front, a home equity loan is the better option.

THE BOTTOM LINE

Rising home prices have created record levels of equity for U.S. homeowners. However, many people are unaware of how to leverage home equity to help with home improvement costs, consolidate debt or even cover retirement costs. And although these are the top cited reasons for tapping into home equity, you have the ability to use the funds for non-home improvement investment purposes that can have a significant impact on your personal goals, whatever they may be.

Still, it's important to proceed with care when borrowing against your home because failure to make timely payments can result in foreclosure.