How To Use Equity in Your Home: The Best (and Worst) Ways
One of the many perks of homeownership is seeing your home’s value rise because of market factors, allowing you to gain equity without much effort. Due to rising home prices, U.S. homeowners saw an average $28,000 gain in home equity between March 31, 2023, and March 31, 2024.
But just because you have equity doesn’t mean you know what to do with it. We’ll cover the smartest ways you can use your home equity, as well as the financial moves you should avoid.
Home equity is the difference between how much your home is worth and how much you owe on your mortgage. As you make mortgage payments, your mortgage’s principal balance goes down and you build home equity.If your mortgage balance is lower than your home’s value, you have positive equity that can be converted into cash. When your mortgage balance is higher than your home’s value, you have negative equity — this is often called being “underwater” on your loan.
A cash-out refinance may be the most familiar way to convert some of your home equity into cash. A cash-out refinance allows you to replace your existing mortgage with a home loan for more than what you owe. You pocket the cash difference between the two loans.
How to get equity out of your home without refinancing
- A home equity loan, which is disbursed to you in a lump sum. The loan is repaid in monthly installments over a set term of five to 30 years (similar to your mortgage). Home equity loan rates are typically fixed.
- A home equity line of credit (HELOC), which is a revolving credit line that works like a credit card. You only pay back what you spend, plus interest, and your credit line can be reused as long as you have access to it. HELOC rates are usually variable, but fixed-rate HELOCs may be an option.
The 6 best ways to use home equity
Home improvements
It can be a smart move to leverage real estate equity to cover your next home improvement project, though not all improvements offer the return on investment you may be looking for.
Of course, there are times when home improvements have to be done, regardless of whether you can earn back what you invested in doing them. If you desperately need a new roof to avoid leaks and other damage to your home, for example, that would be a smart way to use home equity, no matter how it may impact your home’s value.
More perks: Another benefit to leveraging your equity to pay for home improvements is that you may be able to deduct mortgage interest paid on a home equity loan, HELOC or cash-out refinance at tax time. You’ll lose that perk if you tap equity for other reasons.
Real estate investing
You could also use your equity to jump into real estate investing. Let’s say you’re interested in getting an investment property loan to buy a rental property. One of the key requirements is a minimum 15% to 20% down payment. That large amount of cash can be tough to come up with, but it’s a far lower barrier if you can convert some of your home equity to cash.
More perks: Once you’ve built up significant equity in your first investment property, you can rinse and repeat the process by leveraging equity in that property to invest in more real estate. Real estate investing can really beef up your ability to build passive income and long-term wealth.
Higher education expenses
The national student debt load is about $1.6 trillion, according to data from the Federal Reserve Bank of New York, and the average debt balance for federal and private student loans is around $40,000. That’s a ton of money for almost anyone, but homeowners with college-aged kids may have a distinct advantage: They can leverage their home equity to help fund higher education expenses.
More perks: You could help your child reach educational goals, which, in turn, can lead to an increase in their future earnings. You could also improve their quality of life, since student loan debt can impede saving for a down payment, building an emergency fund and access to future loans, including getting a mortgage.
Medical expenses
If you’re struggling to cover medical bills, your home equity could provide some relief. By tapping your equity to erase that medical debt, you can escape incessant harassment from debt collectors and work toward reversing any negative effects to your credit score.
More perks: Medical debt can be especially crushing if you’ve had to resort to high-interest credit cards to cover those bills. But if you rely on your home equity instead, you’re almost certainly going to secure a lower interest rate and monthly payment in the process.
Debt consolidation
Depending on how much debt you have, it might be beneficial for you to use your home equity for debt consolidation.
What to watch out for: Leveraging equity in this way is only a smart move if you refrain from racking up more debt after it’s paid off — otherwise, you’re just replacing your current debt, which isn’t tied to any collateral, with new debt that’s tied to your home.
Refinance
It may sound less attractive than other home equity products, but a simple refinance can achieve a lot. Most refinances will get you into a new loan with a better interest rate and/or lower payments than you had with your purchase mortgage. That alone can free up some room in your budget to help cover other expenses or financial goals. However, to truly make the most of your equity you can choose a cash-out refinance, which will provide you with a lump sum of cash.
More perks: If you’ve reached at least 20% home equity, a refinance is a great way to get rid of private mortgage insurance (PMI) payments.
The 3 worst ways to use home equity
Borrowing against your equity means tying new debt to your house — so it always involves exposing yourself to additional foreclosure risk. Avoid tapping your equity for any of the following purposes.
Splurging on vacations
Sure, exploring Tahiti in French Polynesia sounds like an unforgettable experience, but it’s not wise to finance nonessential travel with home equity. Unless you truly think a trip is worth losing your home over, it just doesn’t make sense to trade one week of rest and relaxation for a second mortgage.
Covering everyday expenses
If you’re finding it difficult to manage your monthly bills already, taking on more debt just creates a larger problem. Instead, contact your lender to request a mortgage forbearance or a loan modification. Lenders understand that you need help when facing a temporary hardship and will work with you to avoid falling behind on your mortgage payments.
Buying depreciating assets
Think twice about using your home equity to buy a brand-new car or furniture. These items depreciate in value over time, and you can’t truly enjoy either if you lose your home.