Mortgage Basics: How To Tap Into Your Home Equity

An undercurrent began brewing during the pandemic. While the “sheltering at home” movement quickly took hold, kids got schooled at home, parents dressed from the waist up to place themselves in front of their computer screens to stay employed, and people began taking good, hard looks at their homes. What works? What doesn’t? What could they change to make it the ideal work/study/frolic/sleep environment as real estate prices began skyrocketing and along with it, home equity began growing as well?

Pulling equity out of a home is nothing new, but it was during the pandemic that homeowners began to understand the beauty of staying in place and tapping on what they already own. Borrowing money based on your home’s value can pay for everything from consolidating debt to a wedding to a big trip abroad. But among the best ways to use that money is to sink it into the entity that created it — your home. Home equity means receiving a lump sum upfront and repaying it in monthly installments—plus interest—over a period of time lasting typically from five to 15 years.

Realtor’s Daniel Bortz looks into how homeowners make equity work for them. “Home equity loans are a popular option for homeowners because their interest rates are much lower than those for other common forms of borrowing, such as personal loans or credit cards,” says Tendayi Kapfidze, chief economist at Lending Tree. “And since home equity rises alongside real estate values, they’re a boon to many homeowners.”

For the past few years, homeowners have been gaining home equity at an extremely fast rate. Bortz also quotes banker Jon Giles, who says that in the last two years, he has seen an increasing demand for home equity loans.

Is this a consideration for you? First, it’s wise not to see it as a gold mine being dumped in your backyard. Rather, see it as a solution to a particular problem — a house renovation, college tuition, a down payment on a vacation home or investment property, or perhaps even to buy a car or pay for emergency expenses. “Unfortunately, some people squander the money, obtaining a home equity loan to fund their discretionary spending. Not a great idea,” says Bortz. He goes on to cite Bankrate’s Greg McBride, who adds that tapping your home equity to take a vacation, buy a yacht, or get plastic surgery would definitely be a misuse of the funds.

It’s important not to confuse a home equity loan with a home equity line of credit (HELOC), which functions more like a credit card. HELOCs enable you to borrow up to a certain amount of cash and then pay it off or reborrow as needed over the term of the loan (usually five to 20 years). In fact, your lender will issue you a small plastic card that looks just like a credit card, to allow you to access your money easily. Here is where to beware, however, since HELOCs generally have a variable interest rate, as opposed to home equity loans which typically have a fixed interest rate. With today’s interest rates, not knowing what your payment might be each month can spell disaster.

To qualify for a home equity loan, you first need to have a sufficient amount of equity built up. Most mortgage lenders will allow you to borrow up to 80% of your home’s equity when you obtain a home equity loan, which is almost like a complete refinance but with cash gleaned from it. Strong credit is also a must. While most mortgage lenders require a credit score in the upper 600s or higher to qualify, one in the mid-700s and higher will help you qualify for the best interest rates. Lastly, an adequate debt-to-income ratio is necessary. That translates into a simple equation of your monthly debt payments divided by your monthly income. Generally, your DTI ratio cannot exceed 43% of your gross monthly income.

It’s also wise to make sure you understand how a home equity loan is going to affect your overall financial picture before diving into one. Think long and hard about how you’re going to pay back the money before you remodel that kitchen, add the extra room to your home or throw a granny flat in your backyard. Once you’ve got that straight in your head, go forth and enjoy the equity your home has created for you.

Realtor, TBWS