Most homeowners now have more equity in their homes than two years ago, thanks to soaring home values during the pandemic. This means that now is a good time to consider tapping into your home equity if you are looking to borrow money at a lower interest rate than you could get with other types of loans such as personal loans. Home equity is the difference between what you owe on your mortgage and the current market value of your home.

You increase the equity in your home by making regular mortgage payments over the years. Equity is valuable because it allows you to borrow money on your house at lower interest rates than other types of financing. Once you have sufficient accumulated equity in your house, lenders and banks will allow you to borrow against it. Some of the most common reasons to borrow against your principal are to pay for living expenses such as home improvements, higher education costs such as tuition, or to pay off interest rate credit card debt. high interest.

Most lenders want to make sure you’ve built up at least 15% to 20% equity so you can borrow money against your home in the form of refinancing or other types of home equity loans. One of the easiest ways to ensure you have a good share of the equity in your home is to make a big down payment if you are able.

For a typical homeowner with a 30-year fixed rate mortgage, accumulating from 15% to 20% usually takes about 5-10 years. Even though you paid less for your home when you bought it years ago, your equity is based on the current value of your home. If, for example, your home is currently worth $500,000 and you have $400,000 left to pay on your mortgage, you would have $100,000 of equity in your home.

Here’s what you need to know about home equity, what it is, how to calculate it, and why it matters to homeowners.

How do you calculate the equity in your home?

To calculate the equity in your home, simply subtract the remaining balance of your mortgage from the current market value of your home. So if you owe $400,000 on your mortgage and your home is worth $500,000, you have $100,000, or 20% equity in your home. You may need to work with an appraiser or real estate agent to get an accurate assessment of the fair market value of your home, especially since home values ​​have risen at a record high since the start of the pandemic.

Ways to borrow against home equity

There are different ways to access the equity in your home. Some of the more common equity financing options are home equity loans, home equity lines of credit (or HELOCs), and reverse mortgages. However, it is important to keep in mind that all of these options require you to pledge your home as collateral to secure the loan. It is therefore essential to understand that there is a risk of losing your home to foreclosure if you miss payments or are in default of payment for any reason.

Home Equity Loan

A home equity loan lets you borrow money against the equity in your home and provides you with a lump sum cash payment at a fixed interest rate. Lenders generally want to see that you have at least 15% to 20% in your home to approve you for a home equity loan. A home equity loan does not replace your mortgage like a refinance, rather it is a brand new loan that you will repay monthly with your existing mortgage payment. But just like a mortgage, with a home equity loan your interest rate never changes and your monthly payments are also fixed.

HELOC

A home equity line of credit, or HELOC, is a type of loan that lets you borrow against the equity you’ve built up in your home and works like a credit card. It gives you an open line of credit that you can access for a certain period of time, usually 10 years, followed by a set repayment period, which is usually 20 years. Lenders also generally want you to have at least 15% to 20% in your home for HELOC approval. With a HELOC, you don’t have to withdraw all of your funds at once, and you can withdraw money multiple times from your HELOC over a 10-year period after previously borrowed money is repaid.

“A HELOC offers more flexibility than a home equity loan – you cannot withdraw money from a home equity loan as you can with a HELOC, and a HELOC allows you to receive replenished funds when you pay your outstanding balance,” Robert said. Heck, vice president of mortgages at Morty, an online mortgage marketplace.

However, HELOCs have variable interest rates, so it’s important to make sure you can afford higher monthly payments if your rate goes up after your introductory interest rate expires, especially in the economic climate. current.

Reverse Mortgage

You must be 62 or older to access a reverse mortgage and have either paid off your home or built up significant equity, usually at least 50%. With a reverse mortgage, you don’t have to make monthly mortgage payments and the bank or lender actually pays you. However, you still have to pay your property taxes and home insurance and continue to live in the house. A reverse mortgage allows you to access the equity in your home and not repay the funds for an extended period while using them for other expenses during retirement. It’s important to keep in mind that you’re building up a mortgage balance as you borrow against your principal, and your estate will eventually have to repay your loan. A common way to repay this loan is to sell your home.

The bottom line

Unleashing the equity in your home can be a valuable means of accessing finance to cover other living expenses. It’s important to understand the differences between the types of equity loans available in order to get the best one for your particular financial situation. When comparing ways to access equity, always consider the interest rate, additional lender costs and fees, the amount of the loan and how it will be disbursed to you, and the time you have to pay it back, before entering into an agreement to borrow against the equity in your home.