What Is Home Equity — And How Can You Apply for a Home Equity Loan?

Owning a house lets you build up home equity, which is a powerful thing.

More equity means more profit when you sell your house. You can also leverage your home equity and turn it into cash for things like home renovations, paying off debt or achieving other financial goals.

Do you want to know how you can use your home equity? This guide can help.

Table of contents

• What is home equity?
• Home equity options
• How to qualify for home equity products
• Home equity FAQs
• Summary of our guide to home equity

 

What is home equity?

Home equity is the difference between the market value of your home and the remaining balance on your mortgage. In short: It’s the stake in your home that you actually own.

Your equity changes over time. As you pay off your mortgage, your equity increases. If your home rises in value, your equity increases, too. (Conversely, if its value drops, so does your equity stake).

How does home equity work?

Home equity is based on your home’s value and the balances on any mortgages or loans you have against the property. So, as your home’s value increases or you pay down your mortgage’s principal balance, you build equity.

Once you’ve built up enough equity, you can use it by borrowing money from it through a loan or line of credit.

Home equity options

Your equity translates into profit when you sell your home. However, while you’re still living in the property, you can also borrow against that equity when you need cash.

There are three options for homeowners looking to do this: a home equity line of credit (HELOC), a home equity loan or a cash-out refinance. All three allow you to turn your equity into spendable funds, but they function slightly differently. Here’s what you should know about each.

Home equity line of credit

HELOCs let you turn a portion of your home equity into a line of credit. Much like a credit card, you can use the credit line as needed over time — up to your established credit limit.

Most HELOCs have a 10-year draw period, which is when you can withdraw and use the funds. During this time, you’ll typically pay only interest to your lender. After that draw period has ended, you’ll enter the repayment period, which is when you’ll start making full principal and interest payments until the loan is repaid. Since HELOCs often have variable interest rates, the cost of these payments can rise or fall over time.

With some HELOCs, you may have a balloon payment. This means the full balance comes due once your draw period ends.

Home equity loan

A home equity loan is more like a traditional loan. You’ll get a portion of your equity in a single, lump-sum payment after closing and then pay it back monthly over the course of five to 30 years.

Home equity loans usually have fixed interest rates, meaning your rate and payment will stay the same for your entire loan term.

Cash-out mortgage refinance

Cash-out refinancing is another way to leverage your home equity, but unlike your other options, this isn’t a separate loan. Instead, it replaces your existing mortgage loan — only with one that has a larger balance. That new loan pays off the old one, and you get the difference back in cash.

Since it replaces your existing mortgage, cash-out refinancing also means replacing your interest rate and terms, too. This may or may not be advantageous, depending on current interest rates.

Pros and cons of using your home equity

Leveraging your home equity can be helpful when you need cash, but there are drawbacks to consider, too. Make sure to consider the full spectrum of pros and cons before moving forward with one of these loans.

Pros of using your home equity

The biggest upside of using your home equity is that it’s typically more affordable than other financing options. Credit cards, for example, typically have rates that run well into the double digits, and personal loans have rates in the high single-digits.

Home equity loans, HELOCs and cash-out refinances, on the other hand, have much lower interest rates. So if you’d otherwise need to use a credit card or personal loan for whatever expense you’re facing, tapping your home equity could save you significantly on interest costs over time. (For these same reasons, home equity loans can also be a good debt consolidation tool, allowing you to pay off high-interest debt with a much lower-rate product.)

Another plus is that home equity products can potentially allow you to access a large amount of cash. Most lenders allow you to tap anywhere from 80% to 90% of your property value, minus your mortgage balances. So if your home is worth $500,000, and you only have $150,000 left on your current mortgage, you could potentially access up to $300,000 (500,000 x .90 – 150,000).

Cons of using your home equity

On the downside, using your home equity can be risky. For one, it reduces the profits you’ll get when you sell, and if your home decreases in value, it could mean owing more on the property than it’s worth.

Perhaps the biggest drawback is that it puts your home at risk of foreclosure. If you fall on hard times and are unable to make your payments, the lender could seize your house to pay off the debt.

Home equity loans vs. HELOCs

The biggest difference between home equity loans and HELOCs is that a home equity loan comes with a lump-sum payment, while a HELOC lets you withdraw funds over time. They also have different interest rate types and repayment schedules.

Here’s a look at how home equity loans and HELOCs differ.

Generally speaking, HELOCs are best if you’re not sure how much you need or if you need access to funds over an extended period. Home equity loans are a good choice if you have an accurate idea of what you need to borrow and you want a consistent, fixed payment that you can rely on.

 

How to qualify for home equity products

Every loan product and lender has its own qualifying requirements. In all cases, you can expect your credit score, debt-to-income ratio, loan-to-value ratio and your equity to play a role.

Here’s a general look at what you might need to qualify for a home equity loan, HELOC or cash-out refinance, though it varies by lender.

Equity	At least 10% to 20%
Credit score	620 or higher
DTI	43% or lower
LTV	80% to 90%

Keep in mind that these requirements can vary widely from one lender to the next, so make sure to shop around if you’re considering a home equity product. There’s a chance you may qualify with one company and not the next. Use our guides to the best home equity loans and the best mortgage lenders to get started.

How to apply for home equity products

Applying for a home equity loan, HELOC or cash-out refinance is much like applying for a traditional mortgage. You’ll need to fill out an application, agree to a credit check and submit various forms of financial documentation.

You also may owe closing costs, in many cases, and your home will need to be appraised too. This helps the lender confirm your home’s value, as well as how much equity you have to borrow from.

How to calculate your home equity

Calculating your home equity is a simple process. You take your home’s value and subtract the balance of any mortgages or loans against it.

So, for example, if your home’s valued at $350,000 and you have a $200,000 mortgage balance and a $50,000 home equity loan balance, you have $100,000 in equity. (350,000 – 200,000 – 50,000).

Summary of our guide to home equity

Homeownership lets you build equity, which you can turn into cash with various financial products, like home equity loans, HELOCs and cash-out refinances. You can then put those funds toward home improvements, medical bills, college tuition or, as many consumers do, to pay off debt.

It’s important to shop around for a lender and consider all your options first. And if you’re not sure, consult a professional. A loan officer, mortgage broker or financial advisor can help you determine which option is best for your goals and budget.