Compare Options for Tapping Your Home Equity

Your home's equity becomes one of your assets when you buy a house. In the beginning, your equity is usually equal to your down payment. Over time, your home equity will increase as you pay down your mortgage balance and the value of your home increases.

Once you've built equity in your home, you may want to use it to fund other expenses or fulfill your financial goals. This guide explains three ways to borrow against your home equity so you can see if one of these options is right for you.

3 Ways To Borrow Against Your Home Equity

There are three common ways to borrow from your home's equity: a cash-out refinance, a home equity line of credit, or a home equity loan. There are a few things to think about when you borrow against equity, though.

• Regardless of the loan type you choose, you'll apply for the loan and submit financial documents
• Your lender will check your credit and financial situation, just like with your initial mortgage.
• You'll also likely need a new appraisal for your home to determine its value.
• Closing costs are usually required for these loans. You can pay them from the equity you're borrowing, but this increases interest costs over time and leaves you with less money for other things.
• Refinancing may increase the total amount of interest you pay over the life of the loan.

The upsides usually outweigh these downsides, though -- especially if you select the right type of loan to gain access to your equity. Here are three of the best options.

1. Cash Out Refinance

A cash-out refinance is one way to access the equity in your home. This option replaces your existing mortgage with a new mortgage for a higher amount. This cash-out refinance loan will have a new rate and terms, so this option usually makes sense only if your new loan will have a lower rate than your current mortgage (or the amount you want to borrow is much larger than the amount still owed on the original mortgage).

When your new mortgage closes, you'll receive the extra money you borrowed that you didn't need to pay off your old loan. For example, if your existing mortgage balance is $150,000, a cash-out refinance could replace your current mortgage with a new one for $170,000, and you'll receive $20,000 in cash at closing.

Keep in mind that lenders typically require you to own your home for at least six to 12 months and have at least 20% equity built up to qualify for a cash-out refi. This timeline can vary by loan type and lender, though, and you must meet all other credit and income requirements.

2. Home Equity Line of Credit

A second option is to use a home equity line of credit (HELOC), which is very similar to a credit card, except it is secured by your home and has a much lower interest rate than credit cards usually do. Most HELOCs have adjustable rates.

With a home equity line of credit, you don't get a lump sum payment up front. You are given access to a line of credit you draw from as needed. This can be useful for ongoing projects when you don't know how much cash you might need or when you'll need it.

3. Home Equity Loan

Finally, you can tap into your equity with a home equity loan, which is also called a second mortgage.

A home equity loan is similar to a cash-out refinance because you get a lump sum of money at closing. However, a home equity loan is a separate second loan on your house. It can have a different rate and term than your current home loan, and it often requires a separate payment to a second lender. Your existing mortgage isn't affected.

A home equity loan is a good option if you want a lump sum amount up front and a fixed-rate loan, and you don't want to change the terms of your current loan.

Tapping Home Equity FAQs

If you still need to know more details, here are the answers to frequently asked questions about tapping home equity.

How Much Equity Can You Borrow from Your Home?

Lenders typically limit your total loan balance to no more than 80% of the market value of your home (with the exception of VA loans). So, if you have a $400,000 home and you already owe $300,000, you'd probably only be able to borrow around $20,000 more for a combined total of $320,000 in debt. To estimate how much cash you might be able to borrow, use our cash-out refinance calculator.

How Soon Can You Take Equity out of Your Home?

Some lenders allow you to take equity out of your home immediately after you have purchased the property. However, there may be a waiting period or a seasoning period. If you are taking out a cash-out refinance loan, you are more likely to have to wait before being able to borrow. Typically, a seasoning period would last around six to 12 months.

When Is the Best Time To Use Home Equity?

Using home equity can make sense if you can qualify for a low interest rate and if you have a strategic purpose for the money you're borrowing. For example, if you can qualify for an affordable loan to pay off debt or make home improvements, a home equity loan would make sense.

Final Thoughts: Are You Ready To Use Your Home Equity?

Freedom Mortgage offers affordable HELOCs as well as cash-out refinancing for conventional, VA, and FHA loans.

Reach out to an experienced mortgage loan professional at Freedom Mortgage today to explore your options, find out which saves you the most money, and get prequalified for a loan that's right for you.