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U.S. home values surged from 2021 to 2022 and delivered hefty boosts in home equity to millions of homeowners. Home prices have since flattened and even begun to decline in some markets, but the total value of all U.S consumers' home equity is at an all-time high, according to the U.S. Federal Reserve Bank of St. Louis.
Economic factors such as rising inflation and interest rate hikes have many Americans considering converting some of their newfound equity into cash to pay down increasingly costly credit card debt or other high-interest credit. This might not be the best choice for every homeowner, however. Here's how to decide whether to tap into your home equity.
How Can I Tap Into Home Equity?
Home equity is your home's market value minus what you owe on your mortgage (and any other loans that use your home as collateral). Equity grows as you pay down those loans, and it also increases along with your home value. When your mortgage and all other home-backed loans are paid in full, your equity is 100%.
You can think of home equity as the portion of your house that you own outright. Equity is an asset—the largest one many homeowners possess. Rising home values have resulted in a home equity boom that has many Americans considering ways to convert some or all of this asset to cash.
You can convert your newfound home equity into cash by borrowing against it. When approving a loan application, lenders will typically require an appraisal that determines the value of your home (and thus the amount of equity you hold) and helps them set borrowing limits.
Consider the following loans if you're looking to tap into your home equity.
A cash-out refinance entails taking out a new, larger mortgage that replaces your current one. You'll use much of the new loan to pay off your existing loan and receive the excess in cash when you close the loan. Rates on cash-out refinance loans are typically a fraction of an interest point higher than you'd pay on a standard mortgage or refinance for the same sum, though typically lower than on a personal loan.
Cash-out refinance loans were a popular option in the 2010s and the pandemic era as mortgage interest rates fell to historic lows. Borrowers could often use a cash-out refi to obtain cash and reduce their mortgage rates at the same time, ideally lowering their overall loan costs. But in today's climate of rising mortgage rates, those opportunities are harder to come by, particularly for borrowers who obtained fixed-rate mortgages at the previous decade's rock-bottom rates.
A cash-out refinance still could make sense for you if your current home loan is an adjustable-rate mortgage (ARM), as its rate is all but certain to increase in the years ahead (and may have done so already). If you can replace an ARM with a fixed-rate loan, even at today's rates, that could still save you money over the long haul, and perhaps allow you to take some cash as well.
Home Equity Loan
A home equity loan lets you borrow as much as 80% to 85% of your home equity in a lump sum, to use for any purpose you choose. You'll pay it back in a series of monthly payments over a fixed term that can range from five to 30 years, as spelled out in the loan agreement.
Home equity loans use your home as collateral and are considered second mortgages. They typically come with fixed interest rates that are somewhat higher than those offered on primary mortgage loans. This reflects the fact that if you fail to repay your loans or file bankruptcy, the issuer of the second mortgage can only collect from the sale of your house after the primary mortgage lender collects what it is owed.
Rising interest rates affect the costs of home equity loans just as much as they do primary mortgages and other loans, but for borrowers with low-rate primary mortgages, a home equity loan may be more practical than a full refinance, because the new loan's rate applies only to the cash loan amount, not the entire value of the house.
Prior to passage of the 2017 federal tax reform law, home equity loans were popular for financing home improvement projects because the IRS permitted many taxpayers with total mortgage loans of $750,000 or less ($1 million or less for couples filing jointly) to deduct home equity interest charges from federal income taxes if they used the loan for home repairs or renovations. The 2017 law removed that option, effective through 2025. It's possible that interest on a home equity loan you take today will become deductible again after the 2025 tax year, but that's not a certainty.
Home Equity Line of Credit
Like a home equity loan, a home equity line of credit (HELOC) is considered a second mortgage and may allow you to borrow as much as 80% to 85% of your home equity. But instead of taking it in a lump sum, you're provided a revolving line of credit with the loan amount as your borrowing limit.
For a stretch of time known as the draw period (typically 10 years), you can write checks or make debit card charges against the borrowing limit. You're only required to pay interest on the funds you use, but you can make payments toward your principal balance in any amount during the draw period. At the end of the draw period you can no longer make new charges, and you must repay any outstanding balance in equal installments spread over a set repayment period (typically 20 years).
HELOCs may differ in the lengths of their draw and repayment periods, but those terms are always fixed for a given loan and set out clearly in the loan agreement. HELOCs typically come with adjustable interest rates, but fixed-rate HELOCs are available from some lenders.
As with lump-sum home equity loans, interest on HELOCs was once deductible from federal income taxes if funds were used for home improvement projects, but the 2017 tax reform law has removed that option through the 2025 tax year. It's unclear whether that option will be restored for 2026 and beyond.
Is Tapping Home Equity a Good Idea?
If you're considering borrowing against home equity, it's important to understand that cash freed up from home equity isn't free. All of the methods outlined above can be sources of useful money, but each comes at a cost and brings a measure of risk:
- You could lose your home. First and foremost, using your house as collateral on a loan means you can lose your home if you can't keep up with your payments. You extend that risk by prolonging the amount of time it'll take to pay off your home outright—by taking out a new 30-year refi loan after years of making payments on your original mortgage, for example, or by securing a home equity loan or HELOC that won't be repaid until after you've paid off your primary mortgage. It's important to be confident you'll be able to repay any loan before you take it out, and to borrow only as much as you really need, even if your home equity stake qualifies you to borrow more.
- Rising interest rates could result in a very expensive loan. Recent increases in interest rates, and the likelihood rates will continue to rise at least in the short term, make taking on any adjustable-rate loan extra risky, as its rate will likely follow prevailing rates and increase rapidly.
- You'll likely pay fees for the privilege to borrow. Cash-out refinance mortgages, home equity loans and HELOCs are all subject to origination fees of roughly 2% to 5% of the amount you're borrowing. Be sure to factor in those fees and any other closing costs when calculating the total costs of the loan.
Taking all of these factors into account—in addition to your reasons for seeking the loan—can help you decide if borrowing against your home equity is a good move for you.
Potential Uses for Home Equity Funds
There are no rules or restrictions governing how you use funds you borrow against home equity (and currently no tax incentives either), but it's safe to say that some uses of home equity loans are more prudent than others.
Wise uses of home equity credit include:
- Home improvements: Replacing an aging roof, renovating an outdated kitchen or bathroom, finishing a basement and making an addition are all projects that can increase your home's resale value. Done right, they can at least partially pay for themselves over time, and enhance your daily living in the meantime. Some projects are more likely to reap resale returns than others, and which are most valuable can depend on your home's attributes and your local housing market.
- Debt consolidation: If you have significant credit card balances or outstanding high-interest loans, consolidating those debts with a lower interest rate could help you get those expenses under control. As long as you avoid running up new card debt in the future, that can be a good way to stabilize your finances and bolster your credit.
Once again, there are no hard and fast rules about how you should use funds you borrow against home equity, but it might be wise to think twice (or even three times) before risking your home to fund the following:
- Weddings, anniversary parties, honeymoons or other vacations: Once-in-a-lifetime events are over before you know it, can take years to pay off, and the great memories they make would be tainted if you lost your home because you couldn't make your payments.
- Buying a car, boat or RV: These items can make life more enjoyable, but with very few exceptions, they lose value quickly over time and can be costly to use and maintain. Traditional financing that uses the vehicle itself as collateral might mean paying a higher interest rate than you'd get borrowing against home equity, but if you're ever unable to make payments, you'll only lose the vehicle, not your home.
Alternatives to Borrowing Against Home Equity
If you're concerned your household income may be unsteady or that other circumstances could jeopardize your ability to keep up with payments, it's probably best to avoid risk losing your home by taking on home-equity-based debt. Consider these alternatives instead:
- Borrow from family or other loved ones. If it's an option, using a private loan to finance home repairs or other projects can allow you to make repayments at a more relaxed pace, without the threat of foreclosure or a forced home sale.
- Explore other borrowing options. If your goal for a home equity loan is debt consolidation, consider a personal loan or even a balance transfer credit card as options for getting high-interest card balances under control.
- Use a sinking fund. These can be used to accumulate funds in small increments to pay for vacations, luxury items and other purchases you want but that aren't essential—or worth getting at the risk of losing your home.
The Bottom Line
Newfound home equity is a valuable asset you can borrow against to improve your life in a variety of ways, but it's important to remember that home equity borrowing can increase your risk of losing your home if you fail to make payments. To get the best possible borrowing terms on a cash-out refinance mortgage, home equity loan or HELOC, consider checking your free credit score from Experian and, if appropriate, taking steps to improve your credit score before applying for the loan.