Can You Pull Equity Out of Your House?

Home equity is a homeowner’s financial interest in their property, the portion of the home’s value owned outright. It is calculated by subtracting outstanding loan balances from the home’s current market value. As property values appreciate and mortgage principal is paid down, home equity increases, creating a valuable asset.

“Pulling equity out” refers to borrowing against this accumulated value. This process allows homeowners to convert a non-liquid asset into usable cash. Various financial products enable this, each with unique structures and implications. Understanding these options can help homeowners decide the most suitable approach for their financial needs.

Cash-Out Refinancing

A cash-out refinance involves replacing an existing mortgage with a new, larger mortgage. The new loan pays off the original mortgage, and the difference between the new loan amount and the old mortgage balance is provided to the homeowner in cash. This process essentially creates a new first mortgage on the property.

The cash received can be used for various purposes, such as home improvements or debt consolidation. This type of refinancing results in a new interest rate and loan term for the entire mortgage balance. An appraisal is required to determine the home’s current market value, which influences the maximum loan amount.

Borrowers cannot access 100% of their home’s equity through a cash-out refinance. Lenders limit the new loan to a certain percentage of the home’s value, around 80%. This ensures the homeowner retains some equity. The process involves closing costs, similar to those incurred when obtaining the original mortgage.

Home Equity Loans

A home equity loan functions as a second mortgage on the property. This loan provides a fixed amount of money in a single lump sum to the borrower. The loan is secured by the home’s equity, meaning the home serves as collateral.

This type of loan features a fixed interest rate and a predetermined repayment schedule. Borrowers make regular, fixed monthly payments of both principal and interest over a set term, ranging from 5 to 30 years. The stability of fixed payments makes budgeting predictable.

The amount that can be borrowed is based on the available equity, allowing access to 80% to 85% of the home’s value minus the existing mortgage balance. Home equity loans are used for specific, large expenses due to their lump-sum nature.

Home Equity Lines of Credit

A Home Equity Line of Credit (HELOC) operates as a revolving line of credit, similar to a credit card. Borrowers can draw funds as needed, up to an approved credit limit, repay the amount, and then draw again during a specified period. The home’s equity secures this line of credit.

HELOCs have two distinct phases: a draw period and a repayment period. The draw period lasts 5 to 10 years, during which borrowers can access funds and make interest-only payments on the borrowed amount. Once the draw period ends, the repayment period begins, lasting 10 to 20 years. During the repayment period, borrowers can no longer draw funds and must repay both principal and interest on the outstanding balance.

HELOCs feature variable interest rates, meaning the rate can fluctuate over the life of the loan based on an index plus a margin. This offers flexibility but introduces payment unpredictability. HELOCs are well-suited for ongoing expenses or when the exact amount of funds needed is uncertain.

Key Financial and Eligibility Aspects

Lenders set specific financial and eligibility requirements for accessing home equity, assessing a borrower’s ability to repay and manage risk. A key factor is the Loan-to-Value (LTV) ratio, which compares the loan amount to the home’s appraised value. Lenders require a combined LTV (including the existing mortgage and the new loan) to be no more than 80% to 85% of the home’s value for cash-out refinances, home equity loans, and HELOCs.

Lenders also evaluate a borrower’s creditworthiness through their credit score and debt-to-income (DTI) ratio. A good credit score is 680 or higher, though some lenders accept scores as low as 620. A lower score might result in less favorable terms or a smaller loan amount. The DTI ratio, measuring monthly debt payments against gross monthly income, is important; lenders prefer a DTI of 43% or less to ensure the borrower can manage additional debt. Income stability is assessed to confirm repayment capacity.

Various fees, forming closing costs, are associated with accessing home equity, ranging from 2% to 6% of the loan amount. Common fees include appraisal fees ($300-$800) for market value assessment, and origination fees (0.5%-1% of loan amount) cover processing and underwriting. Other closing costs may include title search, document preparation, attorney, and recording fees. HELOCs may also have annual or inactivity fees.

Interest rate structures vary, with cash-out refinances and home equity loans featuring fixed interest rates. This provides predictable monthly payments over the loan term. HELOCs, conversely, have variable interest rates, which can change periodically based on a chosen financial index. Borrowers with variable rates should be aware that their monthly payments may increase if interest rates rise.

Regarding tax considerations, the interest paid on home equity debt may be tax-deductible under specific conditions. Interest on home equity loans or lines of credit is deductible only if the funds are used to buy, build, or substantially improve the home that secures the loan, as per the Tax Cuts and Jobs Act of 2017 (TCJA) through 2025. Interest on a loan used for a home addition is deductible, but not for personal expenses like credit card debt. The deduction applies to combined acquisition debt (including the original mortgage) up to $750,000 for loans incurred after December 15, 2017. To claim this deduction, taxpayers must itemize deductions on their federal income tax return.