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4 ways to get equity out of your home while rates are high

Heather Petty
Updated
How to get equity out of your home (Rapeepong Puttakumwong via Getty Images)

Among the ways the pandemic affected our lives is that it pushed interest rates to all-time lows by early 2021, prompting an unprecedented spike in home sales, with the Case-Shiller National Home Price Index revealing a 47% increase in the median home price over the past four years. Homeowners who refinanced their mortgages at these new low rates were able to reduce their monthly payments. Yet even those who didn’t likely saw their home values rise, giving them more equity to tap into.

While we're starting to see mortgage rates come down in the wake of June's Federal Reserve policy meeting — where the Fed held its benchmark rate as is for a seventh straight time while signaling cuts to come — home loan rates are still high.

But if it’s cash you’re after to pay for home renovations, knock down debt, invest in property or cover an emergency, your home’s increased value offers a way to unlock money without a personal loan or selling your house. Here’s how to tap into your equity with a home equity loan, HELOC and other mortgage alternatives, and whether you should in this environment of continued high rates.

To qualify for a home equity loan, you must meet a series of requirements that lenders use to assess their risk in taking you on as a borrower, including:

  • Loan-to-value ratio below 85%. Lower LTVs tend to qualify for the best rates.

  • Debt-to-income ratio below 43%. A lower DTI is more likely to result in loan approval.

  • Credit score of 680 or higher. The higher your score, the better rates you’ll qualify for.

  • A solid payment history. Lenders want to see a track record of on-time payments on your current debts.

Requirements can vary from those on this list, with some lenders specializing in borrowers who don’t check all of the boxes, so it’s important to shop around. And with borrowing rates at 20-year highs, it’s especially important to choose a home equity product that comfortably fits your budget.

In the most basic terms, your home equity is the difference between your mortgage balance and what your home is worth. Homeowners build equity in two key ways: as you pay down your mortgage, increasing the equity you own outright, and as the value of your home increases over time.

Home equity is among the most valuable benefits of homeownership, and it offers a useful way to borrow money and pay off debts, renovate your home or cover emergencies through products like home equity loans, HELOCs and cash-out refinance.

🏠 Home equity loan

Borrow against your home’s equity without refinancing

Fast facts

  • Fixed-rate loan

  • Receive a lump-sum payment

  • Terms of 5 to 30 years

  • Consistent monthly payment

  • May require appraisal, closing and other fees

A home equity loan is a fixed-rate loan that allows you to use your home’s equity as collateral. You receive the loan money as one lump sum and pay it back over a series of set monthly payments. This type of loan could be a practical choice if you know exactly how much money you need and how much you can afford to meet your monthly budget.

A home equity loan can also be helpful when mortgage rates are high, because you're paying the higher rate only on the amount you borrow — and not on your full mortgage amount — which sets it apart from a mortgage refinance.

Though current average rates for a home equity loan are at 8% and higher, you’d pay that rate only on the equity you’re borrowing with the loan. And some lenders don’t require closing costs on a home equity loan, which could save you even more.

What to watch for

Anytime you borrow against your equity, you’re using your house as collateral for the loan — which means if you’re not able to repay what you borrow, you risk losing your home.

A home equity loan might also require closing costs that include application, appraisal, underwriting and other fees. Ask your lender about the types of upfront fees you can expect, and weigh them against your monthly costs before taking on the loan.

🏠 Home equity line of credit (HELOC)

Borrow against your home equity as you need it

Fast facts

  • Variable-rate loan, with repayments that fluctuate with market rates

  • Take out only what you need

  • Terms of up to 30 years (10-year draw period of interest-only payments and 20-year repayment period of interest plus principal)

  • Requires annual fee whether you use HELOC or not, and may require closing costs

A HELOC is a variable line of credit — revolving credit that’s similar to a credit card — where your credit limit is determined by the equity in your home. HELOCs start with a 10-year draw period on which you can borrow only the amounts you need, when you need them. After the draw period closes, you typically have up to 20 years to repay what you’ve borrowed, with payments amortized to ensure the total you’ve borrowed is paid off on time.

Unlike a home equity loan, the rate on a HELOC is variable, which means it can increase or decrease depending on market conditions. Yet with inflation cooling, the Federal Reserve is likely to cut benchmark rates later this year, after which borrowing rates are expected to trend down — your HELOC payments likely following suit. (When interest rates are trending up, a loan with a fixed rate — like a home equity loan — might be a better option, especially if you need set payments each month to conform to your budget.)

Depending on your lender, you may be able to make interest-only payments on the HELOC in your initial draw period, though you can often pay toward your principal as well. You might find a lender that offers a fixed-rate option on its HELOC product, which lets you take advantage of falling interest rates during the draw period. If you’re willing to pay a small fee, you can use this option to turn an amount of money you’ve drawn on your credit line into a fixed-rate loan for repayment.

Say your lender’s interest rates fall to 5% during your draw period. You may decide to roll $10,000 of what you’ve borrowed into a fixed-rate loan at that rate — which could either save you money, if interest rates go back up during your repayment period, or cost you, if interest rates dive further down.

What to watch for

As with a home equity loan, a HELOC is secured by your home’s equity, and you could lose your home if you can’t repay or default on your loan.

A variable interest rate can make it harder to predict what you’ll end up paying over the life of your loan — though with rates expected to fall, it could be to your advantage. You might also need to pay appraisal, administrative and other fees, depending on your lender. Make sure you understand how much money you’ll need up front and over the life of the loan when comparing options.

🏠 Cash-out refinance

Replace your current mortgage with a larger mortgage, receiving the difference as cash

Fast facts

  • Fixed-rate loan

  • Receive a lump-sum payment

  • Terms of 15 to 30 years

  • Consistent monthly payment

  • Requires appraisal and closing costs of 2% to 5% of your loan amount

A cash-out refinance is a type of mortgage loan that replaces your current mortgage with a new, larger mortgage and allows you to take out the difference between them as cash. This type of refinance also replaces the interest rate on your traditional mortgage with the rate you can qualify for in today’s market — which are currently high, especially for this type of mortgage.

That, in addition to the required closing costs, makes this one of the most expensive ways to access your home equity when interest rates are high. If you decide on this option, position yourself for the lowest rate by improving your credit score and reducing your debt-to-income ratio before you apply, and take out only the equity you absolutely need.

What to watch for

A cash-out refinance replaces your current mortgage with a new one, effectively resetting the amount you owe on your home and the timeline you have to pay it off. And you risk foreclosure of your home if you’re not able to repay what you borrow comfortably.

Closing costs can result in paying thousands of dollars up front, though you might be able to negotiate specific fees or ask for discounts from your lender.

🏠 Reverse mortgage

Tap into the cash value of your equity without payments while you live in your home

Fast facts

  • Open to homeowners ages 62 and older

  • Fixed-rate loan pays you from your equity

  • Receive a lump sum or monthly payments, depending on your loan

  • Requires appraisal, closing and other fees

A reverse mortgage — also called a home equity conversion mortgage — is a type of mortgage that’s available to homeowners who are at least 62 years old and either own their home outright or are close to paying off their home. With a reverse mortgage, you take out a loan against your home — with closing costs and interest rates — only instead of making payments to a bank or lender, the reverse mortgage pays you from your home’s equity.

Depending on the mortgage program you use, you might get paid in one lump sum, take monthly payments over a set term or get paid monthly for the rest of your life. Interest and fees are added to your loan’s balance each month, while the equity in your home decreases. As long as you live in your home and can pay property taxes and homeowners insurance, the loan isn’t repaid until you sell your home, either to move or after you die.

As with a mortgage refinance, a reverse mortgage isn’t the best option when interest rates are high, as a high rate can lower the amount of equity you can use. Yet when interest rates decrease, this type of loan can be a way to use your home equity to subsidize your retirement.

What to watch for

High upfront and ongoing fees provide room to pause when deciding on whether to take out a reverse mortgage on your home. This type of mortgage requires hefty closing fees, among them application, appraisal and origination fees and an upfront mortgage insurance premium — a 2% premium based on your home’s appraised value or a maximum lending limit, whichever is higher. This premium is designed to cover losses should your mortgage at maturity exceed the value of your home.

You’ll also pay an annual 0.5% mortgage insurance premium on your outstanding mortgage balance, which accrues each year and is payable when the loan is repaid in full. Other ongoing fees are paid to your lender to cover routine administration of your loan.

Make sure that you understand the fees you’ll pay on top of your homeowners insurance and property taxes before taking out a reverse mortgage.

Obviously, the ideal time to borrow money is when interest rates are low. But financial needs don’t always wait for the market to be just right. The good news is that if you can wait a few months, or even a year, decades-high mortgage rates are expected to continue edging down in 2024 — likely after the Federal Reserve cuts the benchmark rate later this year.

If you can’t wait that long, you can take steps to make sure you get the best rate available to you:

  • Shop around for a lender. It can be daunting at first, but comparing lenders can go a long way to ensure you’re getting the strongest rate and best terms. Research home equity products, and read reviews on forums like myFICO, Trustpilot or Reddit.

  • Work on your credit score. Order your credit report from each of the three credit reporting bureaus at AnnualCreditReport.com, and dispute any errors — such as incorrect balances or paid-off accounts — with the reporting bureau.

  • Pay off small debts. Commit to using some of your discretionary spending to pay off smaller debts or your credit cards to give yourself the best DTI ratio possible.

Also, after you’ve tapped your home equity, be sure to talk with a tax professional. Just as with your mortgage interest, the interest you pay on your HELOC or home equity loan can be a tax write-off for you. But you only get this tax break if, according to the IRS, you use the equity to “buy, build or substantially improve” your home and if the loan meets other tax regulations.

If you don’t have enough equity in your home to qualify for a loan or line of credit, building that equity isn’t going to happen overnight. Still, you can use some of the following tips to help improve your LTV as your home value improves gradually with the market.

  1. Pay your mortgage biweekly. Rather than using the monthly due date you’re given for your mortgage payments, cut your payment in half and commit to making that payment every two weeks. This does two things: It increases the full payments you make throughout the year from 12 to 13, because you’re paying half 26 times, and it reduces the amount of interest that accrues from one payment to the next. That may not seem like a lot at first, but it definitely adds up.

  2. Increase the amount you pay every month. You might need to contact your bank before you employ this strategy, but even increasing your payment by just $50 a month can save you tens of thousands in interest over 30 years and shave months off your mortgage term. Every extra dollar that goes against principal is a dollar of equity for you.

  3. Make home improvements and upgrades. You may not be able to adjust the size or location of your house, but there are ways for you to improve the market value of your home, even on a tight budget. Improving the curb appeal and condition of your interior and exterior can help. And if you do have the cash on hand, upgrading your appliances might help to increase the assessor’s value.

  4. Use extra cash to pay down your principal. Any larger sums of money you get this year, whether it’s a bonus, inheritance or settlement, can be used to pay down the principal of your loan, which is instant equity for you. Just like with an increased payment, if you want to apply extra money to your principal, contact the bank to make sure they direct the funds appropriately.

Increasing your home’s equity takes a lot of commitment on your part, but once your equity is established, you gain the security of knowing you can draw on the value of your home when you need it most.

It depends on how you use the loan. The IRS advises that interest on home equity loans and HELOCs are deductible “only if the borrowed funds are used to buy, build, or substantially improve the taxpayer’s home that secures the loan your home and if the loan meets other tax regulations.” Speak to a tax advisor or specialist to learn how to document your expenses and stay within the law when filing your taxes.

A loan-to-value ratio — or LTV — compares how much you owe on a mortgage against the value of your property, expressed as a percentage. Lenders include your LTV among the requirements necessary for assessing their risk in taking you on as a borrower. Generally, lower LTVs tend to qualify for the best rates.

For home equity loans, finding your LTV typically involves an updated appraisal of your property to determine its current value, which your lender will require. Once you have your appraised value, you can divide the remaining balance on your mortgage by this appraised value to find your LTV.

Say you purchased a $250,000 home with a mortgage you still owe $100,000 on. Now let’s say that property is newly appraised at $500,000 as part of your loan process. In this case, your LTV would be 20% — or $100,000 divided by $500,000 — which tells lenders you have 80% equity in your home.

Some lenders offer interest rate reductions of 0.25% to 0.50% if you sign up for autopay — or automatic payments from a bank account. Call the bank or credit union directly to ask about autopay or any other discounts you might be eligible for.

A debt-to-income ratio — or DTI — compares how much debt you owe against your gross monthly income expressed as a percentage. Lenders use your DTI to determine how likely you are to repay an additional debt, like a home equity loan. Typically, a DTI of 43% is the highest percentage you can have and still qualify for a loan.

To find your DTI, add up the money you owe on monthly debts like credit cards, personal loans or your mortgage. Next, divide your total monthly debt amount by your gross monthly income — or your income before taxes and any deductions.

Say your gross monthly income is $5,000 a month, and you typically pay $700 a month to your mortgage, $500 a month to credit cards and $250 a month to a personal loan — a total of $1,450 in monthly debts. In this case, your DTI would be 29% — or $1,450 divided by $5,000 — which is within the range lenders like to see.

Heather Petty is a finance writer who specializes in consumer and business banking, personal and home lending, debt management and saving money. After falling victim to a disreputable mortgage broker when buying her first home, Heather set on a mission to help people avoid similar experiences when managing their own finances. Her expertise and analysis has been featured on MSN, Nasdaq, Credit.com and Finder, among other financial publications. When she's not breaking down the complexities of finance, she's a young adult mystery writer of an internationally acclaimed series — and counting.

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