Home equity climbs to a new peak
There’s never been a more fortunate time to own a home.
Soaring property values from the past year led to the highest amount of equity on record. The average homeowner sat on nearly $178,000 in “tappable” equity by the end of the third quarter, according to data and analytics provider Black Knight.
With access to increased equity, you can pay off other debt, invest or make renovations. Which begs the question, how do you draw equity out of your home and should you?
In this article (Skip to...)
- What is home equity?
- How to measure home equity
- What is tappable home equity?
- How to take equity from your home
- Advantages of tapping your equity
- Reasons against cashing out
What does having home equity mean?
Home equity is the equivalent of cash value built up in your property. Equity grows annually as you pay down your mortgage and with increases in your house’s value.
Equity first needs to be converted into liquid cash in order to be spent. Most homeowners do this through a cash-out refinance, while some opt for a second mortgage.
“Home price growth in the third quarter added more than $250 billion to Americans’ already record levels of tappable equity,” Ben Graboske, Black Knight’s president of data and analytics, said in the report.
“The aggregate total of $9.4 trillion is up an astonishing 32% from the same time last year and nearly 90% higher than the pre-Great Recession peak in 2006.”
How to measure your home equity
All you need to figure out your total equity is the current value of your home and subtract your mortgage balance.
For example, if your house is worth $275,000 and your loan balance is $150,000, then you have $125,000 in equity.
Getting an up-to-date estimate of your property value requires a little research of comparable home sales in your area, using an online evaluator or getting a professional appraisal done — which should be a last resort due to the associated costs.
Your lender further assists in identifying your home’s current value, according to Jonathon Meyer, The Mortgage Reports loan expert and licensed MLO.
Through the refinancing process, a loan officer could plug in the value and Fannie Mae or Freddie Mac (for conventional conforming mortgages) might accept it through their automated underwriting system. If Fannie or Freddie accepts the value, you can obtain an appraisal waiver eliminating the appraisal fee. You should check with your lender, Meyer said.
Note: Appraisal waivers cannot be obtained on a value over $1 million.
What is ‘tappable’ home equity?
Tappable equity is the total you can actually withdraw from your home’s value. Typically, that amount equates to your overall equity minus 20% of your home’s value.
Mortgage lenders normally want that 20% left as a buffer for financial protection in case the borrower were to default on the loan.
Based on the above example, your 20% buffer comes out to $55,000 ($275,000 x 0.2). That gets subtracted from the total equity amount to give you your tappable equity. In this case, $125,000 minus $55,000 leaves you with $70,000 to draw from.
Like most rules, exceptions do exist. Some lenders will let you go above the 80% loan-to-value (LTV) ratio and borrowers with VA loans could be allowed up to forgo the buffer altogether.
How to take equity from your home
Tapping your equity mainly comes from three options:
- Cash-out refinance: You take out a new primary mortgage to replace your existing loan. The new loan has a larger balance than what you currently owe, with that ‘difference’ returned to you as cash. Refinance closing costs average around 2-5% of the loan amount and usually get taken out of your cash back total
- Home equity loan: A home equity loan (HEL) is a type of second mortgage. You keep your existing mortgage with a HEL and take out a second one against your home equity. HEL closing costs are typically lower, but these loans may have slightly higher interest rates compared to cash-out refis
- Home equity line of credit (HELOC): Home equity lines of credit usually come with variable rates and low or zero closing costs. They work similarly to a credit card, where you have a limit you can borrow up to and repay over and over. You only pay interest on any outstanding loan balance. HELOCs have set ‘draw periods’ after which you have to repay the remaining balance in full
Advantages of tapping into your home equity
Used in a prudent manner, home equity has tangible financial benefits.
That extra influx of money can be used to pay off or consolidate higher-interest debts, such as student loans or medical bills. Or it can increase your home’s value further if used to renovate or improve your property.
In a low mortgage rate environment, borrowing from your home equity to pay off big expenses is likely cheaper — especially in the long run — than other types of loans.
Reasons against cashing out home equity
Every coin has two sides and dipping into your home equity can come with drawbacks as well.
Whether through a refinance or a line of credit, tapping into your home equity comes with taking out a new mortgage. You just want to make sure you’re able to afford whatever your new monthly payments would be.
Additionally, a cash-out refinance likely adds to the lifetime of your home loan which leads to paying more interest for each extra year. Refinancing into a 15-year mortgage versus a 30-year can be an option as well, but that likely comes with higher monthly payments.
To find what refinancing would look like for you, check out our refinance calculator.
What are today’s cash-out mortgage rates?
Interest rates for cash-out refinance tend to skew a little higher than rate-and-term refis, while rates for home equity loans and HELOCs are higher still.
Today’s mortgage rates still hover close to historic lows and would be beneficial for any homeowner who borrowed before they cratered in 2020.
Check your cash-out eligibility and the latest interest rates to see if tapping your home equity makes sense for you.