When Is the Best Time to Take Equity Out of Your Home?
Discover the smartest times to tap into your home equity to help improve your finances and your life.
Bottom Line Up Front
- Leveraging home equity can be a smart option to cover significant expenses, particularly when interest rates are low or if you’ve built up substantial equity in your home.
- Home equity loans and home equity lines of credit (HELOCs) offer comparatively low interest rates, which makes them attractive options for consolidating debt, paying for home projects or covering emergency bills.
- Proactively opening a HELOC also can help you be prepared in case of emergency expenses.
Time to Read
10 minutes
August 26, 2024
More and more, people are choosing to invest in improving their existing properties instead of buying a new home and moving. This trend has led many homeowners to consider tapping into their home equity to fund a variety of needs.
Home equity loans and lines of credit can be good options to access the value you’ve built in your home. These loans often come with lower interest rates compared with other lending products. That’s because the property itself is used as collateral, which lessens the potential risk to the lender.
Before taking action, though, it’s crucial to understand when the best times are to take equity out of your home.
What Is Home Equity?
Home equity is the portion of your home’s value that you own. It’s the difference between your home’s current market value and the amount you still owe on your mortgage. For example, if your home is worth $300,000 and you owe $200,000 on your mortgage, you have $100,000 in home equity.
Your home equity can increase in 2 ways: as you pay down your mortgage principal and if your home’s value appreciates over time. These 2 factors help many homeowners build substantial equity, especially in areas where property values are rising.
SMart MoneY tip
For a more detailed explanation of home equity and how to calculate it, check out our full guide on home equity.
7 Best Times to Take Equity Out of Your Home
Home equity can be a valuable financial resource, but knowing when to tap into it is important. Generally, using your home’s equity makes sense for significant expenses that can improve your financial situation or quality of life in the long term. It’s typically not advisable to use home equity for short-term expenses such as recreational purchases or routine bills.
There are 7 scenarios when taking equity out of your home could be a smart option:
- When you’ve built up enough equity in your home
- When interest rates are low
- When you want to be prepared for emergency expenses
- When you need to pay for big home improvement projects
- When you want an affordable debt consolidation option
- When you need quick money for an emergency expense
- When you want to increase your investments
Let’s explore each one so you can better determine whether it might be a good time to use your home’s equity.
1. When you’ve built up enough equity in your home
Make sure you’ve built up enough equity before you consider tapping into it. This gives you enough money available to borrow while also creating a buffer to help protect yourself and your home against market downswings.
A home equity loan typically works as a second mortgage with a fixed repayment period and slightly higher interest rates. To determine how much you could potentially borrow, consider:
- your home’s current value
- the amount you still owe on your mortgage
- how much equity you’ve built up through mortgage payments and property appreciation
A common rule of thumb is to maintain at least 20% equity in your home after taking out a loan or line of credit. In other words, the amount you owe on your mortgage plus the amount you would owe on a home equity loan or home equity line of credit ideally shouldn’t exceed 80% of the home’s value (the “loan-to-value ratio,” or LTV).
- Example 1: If your home is worth $300,000 and you have no mortgage, then you have $300,000 in equity because you own it outright. Following the 20% rule, you would want to maintain $60,000 in your home, which means your home equity loan or home equity line of credit could go up to $240,000.
- Example 2: If your home is worth $300,000 and you still owe $200,000 on the mortgage, then you have $100,000 in equity. Following the 20% rule, you would want to maintain $60,000 in your home, so you might be able to borrow up to $40,000. That’s because your mortgage plus any home equity loan or home equity line of credit ideally shouldn’t exceed $240,000 in this scenario.
Consideration | Example 1 | Example 2 |
---|---|---|
Home value | $300,000 | $300,000 |
Remaining mortgage | $0 | $200,000 |
Total home equity | $300,000 | $100,000 |
20% of home value, to be retained | $60,000 | $60,000 |
Maximum recommended amount for home equity loan or HELOC | $240,000 | $40,000 |
If you’ve built up a lot of equity, you’ve likely lived in your home for several years. Before tapping into your equity, think about your long-term plans. If you plan to sell your home in the near future, then taking out a home equity loan now might not be the best choice. However, if you plan to stay put for at least a few more years, you’ll have more time to rebuild your equity.
Estimate your home equity
Curious about how much equity you’ve built up in your own home? Learn more about how to figure out your equity and try out Navy Federal Credit Union’s home equity calculator to get a quick snapshot.
2. When interest rates are low
The interest rate environment plays an important role in deciding when to tap into your home equity. When rates are low, borrowing against your home’s equity can be particularly attractive.
Home equity loans and home equity lines of credit often have lower interest rates compared with other types of loans or credit products. That’s because those types of loans are secured by your home, which reduces the lender’s risk. When interest rates are low, these equity products become even more affordable.
For instance, if you’re considering a major expense and current home equity loan rates are significantly lower than rates for personal loans or credit cards, then it might be a smart time to leverage your equity.
Keep in mind that even if current mortgage rates are high, that doesn’t necessarily mean rates for home equity products will be unfavorable. It’s worth exploring your options and comparing them with other lending solutions. Take time to research and compare the rates and terms of different loan types to ensure you’re getting the best deal.
3. When you want to be prepared for emergency expenses
Proactively taking out a home equity line of credit (HELOC) can be a smart strategy for emergency preparedness. You can secure a home equity line of credit when rates are favorable, even if you don’t need the funds immediately. Plus, there’s typically no cost if you don’t use them, which makes this a flexible option. Knowing you have a financial safety net can provide peace of mind.
A HELOC can be particularly useful for unexpected, significant expenses such as major home repairs or unforeseen medical bills. During the draw period of a HELOC, borrowers can make interest-only payments for a certain period, typically ranging from 5 to 10 years. With a home equity line of credit in place, you’re prepared for life’s surprises without the stress of scrambling for funds during an already stressful time.
Make sure you won’t be tempted to tap into these easily accessible funds for anything other than emergency needs. Use this credit line responsibly and make a plan to repay the money on time and in full.
4. When you need to pay for big home improvement projects
Using home equity to fund major home improvements can be a smart financial move. If you’re planning a specific project, a home equity loan provides a convenient lump sum. For ongoing or multi-phase projects, a HELOC offers flexible access to funds as needed.
Many home improvements can increase your property value, potentially building up even more equity. Popular projects that homeowners often finance with home equity include kitchen or bathroom remodels, adding a new room or replacing a roof. These types of improvements can enhance your living space while potentially increasing your home’s value.
You may even be able to deduct the interest paid on home equity loans or HELOCs if you use the funds to “buy, build or substantially improve” your home. However, IRS tax rules can be complex, so it’s best to consult with a tax professional about your specific situation. 1
5. When you want an affordable debt consolidation option
If you’re juggling multiple high-interest debts, using your home equity to consolidate them can be a smart financial strategy. Home equity loans and HELOCs often have lower interest rates compared with other lending products, potentially saving you money on interest over time. A lower interest rate could mean lower monthly payments, freeing up cash in your budget.
For example, if you have balances on several high-interest credit cards or personal loans, you might be able to pay them all off by consolidating with a single home equity loan. This could result in 1 fixed-rate, lower-interest monthly payment instead of multiple variable, higher-interest payments.
Consolidating multiple debts into 1 loan can simplify your finances, making it easier to manage payments. Having a set repayment term can provide a clear path to becoming debt-free. Just keep in mind that you’re using your home as collateral, so it’s important to be confident that you can make the loan payments. Also, be cautious about running up new debt on the accounts you’ve just paid off.
TOOL tip
Use our home equity payment calculator to estimate how much your monthly payment could be for your home equity loan, based on your loan amount and interest rate.
6. When you need quick money for an emergency expense
Although it’s ideal to have a HELOC already in place for emergencies (see #3 above), life doesn’t always work out that way. If you’re faced with a sudden, significant expense and don’t have an emergency savings account or existing home equity line of credit, tapping into your home equity can be a viable option.
Home equity loans or HELOCs can provide access to substantial funds, often at lower interest rates than other emergency borrowing options. However, keep in mind that the application process for a home equity loan or HELOC could take a few weeks, so it’s not immediate cash. You’ll also need to provide documentation of your income, assets and home value.
This borrowing option can be particularly useful for unexpected major expenses such as:
- Significant home repairs, such as a failed heating system or a damaged roof
- Unforeseen medical bills not covered by insurance
- Emergency travel expenses
While using home equity can be a solution for emergencies, make sure you have a plan to repay the funds as quickly as possible to rebuild your equity and reduce interest costs.
7. When you want to increase your investments
For some homeowners, using home equity to boost investments can be a strategic financial move. However, this approach comes with both potential benefits and risks that should be carefully considered.
- Pros: Some benefits include leveraging your home’s value to access funds for investments, potentially earning returns on your investments that exceed the interest cost of the loan and having more opportunities to diversify your investment portfolio.
- Cons: Drawbacks to consider include potentially losing money while still owing on the loan if your investments underperform, unforeseen negative impacts on your investments due to market volatility and your home being at risk if you can’t repay the equity loan or home equity line of credit.
A common way to use home equity for investments is to purchase additional real estate, such as a rental property or vacation home. You may be able to deduct the interest paid on your taxes if the property qualifies as a second home. However, tax rules can be complex, so it’s crucial to consult with a tax professional about your specific situation.1
Before using home equity for investments, consider:
- your risk tolerance
- your overall financial situation
- the potential returns versus the costs of borrowing
- your ability to repay the loan, even if investments underperform
It’s highly recommended to consult a financial advisor before using home equity for investment purposes. They can help you assess whether this financial strategy aligns with your goals and your personal risk profile.
How to Get Equity Out of Your Home
Once you’ve decided that tapping into your home’s equity is the right move for your financial situation, you’ll need to understand the process and your options.
Here’s a quick overview of steps to take to access your home’s equity:
- Determine your available equity. Estimate your home’s current market value, then subtract your remaining mortgage balance. Remember, most lenders require you to maintain at least 20% equity in your home.
- Choose your equity product. There are 3 main ways to access your home equity:
- A home equity loan is a lump-sum loan with a fixed interest rate and set repayment term. It’s ideal if you need a specific amount for a one-time expense.
- A home equity line of credit (HELOC) provides a revolving line of credit that you can draw from as needed. HELOCs typically have variable interest rates and are great for ongoing expenses or projects.
- A cash-out refinance involves refinancing your existing mortgage for more than you owe and taking the difference in cash. It’s worth considering if current mortgage rates are lower than your existing rate.
- Gather necessary documents. You’ll typically need to provide proof of income (pay stubs, tax returns), bank statements, property tax bills and homeowners insurance information.
- Apply with a lender. Shop around to compare rates and terms from different lenders. Consider starting with your current mortgage lender or your primary financial institution.
- Get your home appraised. The lender will usually require a professional appraisal to confirm your home’s value.
- Go through underwriting and approval. The lender will review your application, credit history and home value to make a decision.
- Attend closing to secure funds. If approved, you’ll sign final documents and, in the case of a home equity loan or cash-out refinance, receive your money.
Accessing your home equity can provide financial flexibility, but it’s important to have a solid plan for using and repaying the funds. Your home secures the loan, so defaulting on payments could put your property at risk.
SMart MoneY tip
For more detailed information on the application process, check out our guide on How to Apply for a Home Equity Loan or Line of Credit.
Find Out More About Tapping Into Your Home’s Equity
At Navy Federal Credit Union, we’re committed to helping you make informed decisions about your home equity. You can find additional information about home equity in our MakingCents financial education center. In addition, we offer both home equity loans and home equity lines of credit to suit your unique needs. If you’d like to explore your options, our experienced loan officers are ready to help you discuss your best path forward.
Disclosures
The interest on the portion of the credit extension that is greater than the fair market value of the dwelling is not tax deductible for Federal income tax purposes. Consult with your tax advisor for more information about tax deductibility.
↵This content is intended to provide general information and shouldn't be considered legal, tax or financial advice. It's always a good idea to consult a tax or financial advisor for specific information on how certain laws apply to your situation and about your individual financial situation.