Real Estate

Here's how to tap your home equity safely

Key Points
  • Over the course of 2017, the amount of equity borrowers could take out of their homes, or so-called tappable home equity, rose by $735 billion.
  • Home equity is valuable savings, but it can also be a valuable finance tool.
  • Most lenders require you to keep at least 20 percent equity in your home, just as a cushion in case home prices fall.
How to use your home as a source of cash
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How to use your home as a source of cash

Fast-rising home values have more homeowners sitting on newfound home equity. Home equity is the current value of a home minus the amount of mortgage debt against it.

Over the course of 2017, the amount of equity borrowers could take out of their homes, or so-called tappable home equity, rose by $735 billion, the largest annual increase by dollar value on record, according to Black Knight. This brought the collective amount nationwide to $5.4 trillion, which is 10 percent more than at the pre-recession peak in 2005.

Home equity represents valuable savings, but it can also be a valuable finance tool. Homeowners often tap it to pay for other expenses, like education, home repairs or remodeling – or to pay off other, more expensive debt.

So what is the best way to do it?

First, remember that most lenders require you to keep at least 20 percent equity in your home, just as a cushion in case home prices fall. If you don't have more than 20 percent equity, then you are unlikely to qualify.

If you do have at least 20 percent, the most common ways to tap the excess equity are through a cash-out refinance or a home equity loan.

For a cash-out refinance, you refinance your current mortgage and take out a bigger mortgage. For example, let's say your home is worth $100,000 and you have a $40,000 mortgage on it. Remember, you have to keep 20 percent in, so $20,000. That means you have $40,000 in equity to tap. You refinance your current mortgage to up to $80,000. Pay off the old loan and have $40,000 left in cash.

This is a good plan if interest rates are currently lower than the rate you have on your old mortgage. If not, a home equity loan might be a better option.

A home equity loan can be a second loan on your home. So you keep the first mortgage and take out another. You can do this in a lump sum or a home equity line of credit, which is like a checking account on your house. Lenders call these HELOCs for short. You only pay interest on what you take out. Home equity loans can be interest only, but after 10 years you have to start paying principal.

There will be fees for all of these options, and the more money you take out, the higher your monthly payment will be. Make sure you can swing it. A house can be a great finance tool, but it's also a great way to save equity for the future.