How to use home equity: 5 things to do with a HELOC 

You may think of your home as a place for hosting barbecues in the summer, sheltering from the elements or spending time with your family, but it also represents a large financial investment. Not only do you hope to gain a return on this investment when you sell your home at some point in the future, but you can also use the equity in your property as a financial tool while you own it.

Understanding how to use home equity can help prepare you to weather life's twists and turns, from unexpected medical bills to home renovations or new investment opportunities.

What is home equity?

When you purchase a home, most likely you'll use some of your savings for a down payment combined with a mortgage loan. The value of the home not covered by your mortgage is considered equity or your ownership stake in the property. As you pay down your mortgage or the market value of the home grows, your home equity will increase.

You may want to access the equity in your home for a variety of purposes, from updating your kitchen to funding your kids' college education or even paying down higher-rate debt. Many people look to take advantage of their home’s value when they have built up at least 15% to 20% equity in the property.

Start by comparing home equity options to determine which one makes the most sense for you. Three popular options used for tapping into home equity include:

• Home equity loan. Sometimes referred to as a second mortgage, this fixed-rate loan is secured by your home and paid back in monthly installments over time.
• HELOC. A home equity line of credit or HELOC provides a set amount of credit secured by your home. This line of credit does not need to be used immediately, and you only pay it back when you start using it. The limits for home equity lines of credit typically run much higher than credit cards. Many lenders offer interest-only payment terms during an initial borrowing or draw period, typically 10-15 years.
• Cash-out refinance. Access equity in your home by refinancing your existing mortgage and rolling it into a new, larger loan. At closing, your lender will issue a check for the equity portion of the new loan.

How do you calculate your home equity?

To calculate home equity, start by measuring the current value of your home. Recent sales of comparable homes in your neighborhood can give you an idea of your home's worth. For a more exact number, you may want to secure a professional home appraisal. Once you know the value of your home, subtract your current mortgage balance to arrive at the home equity amount. For example, if you estimate that your home is worth $400,000 and your current mortgage balance is $100,000, your total equity in the home equals $300,000.

How to use home equity: 5 smart things you can do

Tapping into home equity provides an alternative to taking out a higher-rate personal loan, running up a credit card balance or dipping into your savings. Here are five examples of smart ways to use home equity.

1. Put it back into your home

Home renovations are one of the most common reasons for using the equity of a property. Use the current equity in your home to further enhance overall value by updating the kitchen with popular materials like granite countertops or increasing square footage by adding a second floor. Based on the size and scope of your renovation project, either a home equity loan or a HELOC may get you there. If you're unsure about the type and amount of renovations, a HELOC offers added flexibility in case your project comes in under or over budget.

2. Consolidate debt

This is probably the least fun reason to access home equity, but consolidating debt can be a practical option. For example, you may be wondering, "Should I pay off my credit cards with a HELOC?" Often, the answer depends on interest rates.

Consider incorporating a lower-rate home equity loan or HELOC into your financial planning to help consolidate your higher-rate debt. Start by comparing the interest rate offered between a home equity line of credit and your existing debt, such as credit cards or auto loans. If you choose to refinance your mortgage or open a home equity loan, don't forget to add in closing costs before making this decision.

You could also use the equity in your home to help pay off student loans or pay back medical debt. In particular, you might find that a HELOC can streamline payments, increase your financial flexibility and may even help improve your credit score over time. As you work through the available options, talk with a financial professional to make sure you're making the right decision given your needs and situation.

3. Approaching or living in retirement

Whether you're near or already living in retirement, there are a few ways you can use your home equity to improve your quality of life. If you need to unlock cash flow, a HELOC could be a good option. You could also consider a cash-out refinance that will transfer the equity in your primary home into a down payment on a rental property to generate additional retirement income.

If your physical needs change but you don't want to leave your home, you can use a HELOC or home loan to cover the cost of accessibility renovations, like a first-floor master suite or accessibility ramps. If you decide to go back to school for a second-act career, you could pay for education using a HELOC to help you achieve your dream. And if your stock market investments take a hit, a HELOC may come in handy during temporary downturns.

4. Whatever comes up

Having equity available can alleviate stress. When financial difficulties come out of nowhere, like the need to take time off work to care for a family member, you'll feel better when you understand how to tap into your property's value to assist with unexpected costs. Rather than pulling from your savings or retirement fund, you can use your home equity to pay for a roof replacement after a storm or a new car when your transmission dies unexpectedly.

If you have the opportunity to get in on a great business idea, your home equity can support this new business venture. After years of diligently making payments on your home, home equity acts as a financial security blanket so you're always ready for whatever life throws at you.

5. Big ticket purchases

Credit cards may make sense for smaller purchases. For larger purchases, a personal loan can be a good option for those who don’t have equity in their home to leverage. But when buying a high-ticket item, consider using home equity as an option. A home equity loan or HELOC generally allows you to take advantage of a lower interest rate or gain more flexibility to repay what you've borrowed.

Countless scenarios exist where you may want to leverage home equity, such as financing a wedding, setting sail on a once-in-a-lifetime vacation or investing in education for yourself or your kids. Maybe you've always dreamed of having a summer home for your family. You can use the money from a home equity loan or cash-out refinance as a down payment on this second property.

Is a HELOC or home equity loan a good idea?

Depending on your current personal and financial situation, a HELOC or a home equity loan could be the right choice. Both a HELOC and a home equity loan, along with a cash-out refinance, provide the benefit of allowing homeowners to easily tap into home equity funds. Here are some other benefits and potential drawbacks of each option to consider:

HELOC benefits

• Flexibility. Borrow only what you need up to a set amount.
• No charges unless you use it. A HELOC can act as a safety net when you’re not sure when you’ll need the funds.
• Delayed repayment. Make interest-only payments during the initial draw period.

HELOC drawbacks

• Variable interest rates. Most HELOCs offer variable interest rates, which could change before you pay off the balance. This could make the ultimate repayment amount less predictable than a home equity loan.
• Complexity. With separate draw and repayment periods, HELOCs can be more complex than a straightforward home equity loan.

Home equity loan benefits

• Stable payments. The set amount of a home equity loan, combined with fixed interest rates, allows borrowers to repay in equal monthly installments, which can make for easy budgeting.
• Lower rates. Home equity loans generally offer lower interest rates than personal loans or credit cards.

Home equity loan drawbacks

• Unaffected by favorable rate changes. Unlike a HELOC, the fixed rates of a home equity loan will not decrease if market interest rates go down.
• Closing costs and fees. Home equity loans charge fees and closing costs similar to a first mortgage loan.

Consider the value your home may hold to reach your goals

While there are differences between the terms and characteristics of HELOCs and home equity loans, both offer the opportunity to access equity in your home. Additionally, home equity loans and lines of credit generally carry lower interest rates than unsecured loan products like credit cards.

If you're looking to fund a large home improvement project or want to consolidate high-interest rate debt, take a look at the value of the four walls around you and consider the benefits of one of the single largest investments you'll ever make — your home.

Interested in opening a home equity line of credit? Learn more about Citizens FastLine®