If you own your home, you may be able to borrow against your equity. On average, each American homeowner has around $216,000 in equity, a significant amount that can open doors to funding for home improvements, educational expenses, and more.
But before deciding to tap into your home equity, it's important to understand how it works and what your options are for borrowing against it. It's also vital to consider that since your home is on the line, you want to make sure the purpose for the loan is for something that is important to you. Then you can see if a home equity loan, a home equity line of credit (HELOC) or another product makes sense for your situation.
What is home equity
Home equity is the portion of your home's value that you don't have to pay back to a lender. If you take the amount your home is worth and subtract what you still owe on your mortgage or mortgages, the result is your home equity. For example, suppose the market value of your home is $200,000. If your mortgage balance is $120,000, then your home equity is $200,000 - $120,000 = $80,000.
You begin building home equity when you make a down payment on a house; making a larger down payment means you start out with more equity. Your equity continues to grow as you make mortgage payments. If you want to build equity faster, you can make additional payments toward your mortgage principal. And your equity can grow if the value of your house increases, either because you improve the property or because the real estate market in your area heats up.
You can use equity as collateral to borrow money. Borrowing against home equity is often less expensive than taking out an unsecured loan or putting purchases on a credit card.
Home equity loans
One way to tap into home equity is to take out a home equity loan. The amount you can borrow depends on factors like your credit score and income. It's typically capped at 85% of your equity. You get the money in a lump sum, and then you make regular monthly payments for a set period of time until you've paid it back. The loan is secured by your home, so the lender has a legal claim on the property in case you don't pay off the loan as agreed. Home equity loans usually have fixed interest rates.
A fixed rate loan has the same interest rate for the entire lending period while the interest rate for a variable rate loan will either increase or decrease over time. Borrowers who prefer predictability may opt for a fixed rate loan. In comparison, variable rate loans may have lower starting interest rates and can be a good choice for short-term financing.
How a home equity loan compares to a cash-out refinance
With a cash-out refinance, you take out a new loan that's larger than your current mortgage. You pay off the mortgage with the new loan, and you get the remainder in cash. You then make monthly payments on the new mortgage.
You might prefer a cash-out refinance to a home equity loan if you'd like to change the terms of your mortgage, such as to lower your interest rate or extend the length of the loan. But if you don't qualify for a refinance with better terms, or if you would face higher closing costs with a refinance and want to keep upfront costs to a minimum, you might want to take out a home equity loan instead.
Home equity lines of credit
A HELOC is a line of credit that's secured by your home. You're given a credit limit, and you can borrow repeatedly if you don't go over the limit. HELOCs often have a draw period, which is the time when you're able to borrow money while paying interest on the amount you've borrowed. After the draw period, you may have to repay what you owe all at once, or you may have the option to pay it back gradually during a repayment period.
Your lender provides checks or a credit card that you can use to access funds from your HELOC. HELOCs often come with variable interest rates, so as noted above, the cost of borrowing with a HELOC can rise or fall over time.
Choosing a home equity loan vs. a HELOC
Home equity loans and HELOCs are similar in that they both allow you to borrow against home equity. And you'll need to provide information about your income and mortgage to apply for either one. But borrowers often use them for different purposes.
A home equity loan gives you cash in a lump sum, so it's a good choice if you need money for a one-time purchase. For example, suppose you're buying all new appliances for your kitchen. If you've chosen the appliances and you know the total amount you're going to spend, you might want to take out a home equity loan to borrow what you need all at once. You can then easily budget for the fixed payments to repay the loan.
On the other hand, a HELOC can be used multiple times during the draw period, so it gives you flexibility. This is an advantage if you need to finance ongoing expenses, or if you're not sure how much cash you're going to need. For example, if you're remodeling your garage, you might first pay a contractor to redo the floor, later buy and install new cabinets, and finally hire a painter. A HELOC gives you the option to borrow exactly what you need at each step, so you don't have to estimate all the costs from the start.
For more on personal finance topics
If you have more questions about home equity loans or home equity lines of credit and other personal finance topics that matter to you, visit the Learning Center on TD Bank's website.
We hope you found this helpful. Our content is not intended to provide legal, tax, investment, or financial advice or to indicate that a particular TD Bank product or service is available or right for you. For specific advice about your unique circumstances, consider talking with a qualified professional