How Much Home Equity Can (and Should) I Borrow?

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Rising home values in 2022 and into 2023 have contributed to overall market volatility and made it more challenging to be a buyer. But this real estate market has proven to be a boon to many homeowners who are content to stay put. That’s because higher home values mean they have more equity than ever. That equity is a potential source of cash they use for purposes ranging from debt consolidation, to home improvements, to funding higher education.

Are you thinking about tapping your home equity to borrow money for these or other purposes? It’s a good idea to understand the limits to what you can borrow and the different ways you can use that equity. They’re not all the same, and some are better suited to particular purposes than others. Keep your financial situation in mind when reading about borrowing equity in your home.

Home equity trends in 2023

2022 was a big year for home equity. According to CoreLogic, national home equity in the fourth quarter of 2022 grew by 7.3% compared to the fourth quarter of 2021, reaching $1 trillion. Meanwhile, according to Inside Mortgage Finance, equity loan originations increased by 4.2% in the third quarter of 2022 compared to the second quarter of 2022.

Nationally, home values are not expected to increase at the same rate in 2023. But even if values stay stable or decrease a bit, many homeowners will find the coming year an excellent time to tap their home equity.

“We don’t have a crystal ball, but I think home values in many markets will continue to appreciate,” says Thomas Bullins, mortgage sales manager, AmeriSave. “So, is this the right time to tap your home’s equity? Well, my perspective is if the transaction today makes sense for a homeowner, they shouldn’t worry about what the market will or won’t do. I’m optimistic that equity will continue to improve over the long run, and people will have more access to it as time goes on.”

Home equity requirements, in brief

Typically, most lenders will allow you to borrow up to 80% of your combined loan-to-value (LTV) ratio, though some mortgage lenders will approve loans or lines of credit for more than that. Your lender will require a good credit score, proof of steady income, and a low debt-to-income ratio. The lender will typically want you to have an LTV ratio under 80% (more about LTV la ter in the article), but this may vary based on product type and lender.

To accurately determine your home’s value (part of the equity calculation), the lender will likely require a home appraisal or other type of home valuation depending on the type of loan selected.

How to calculate the equity in your home

The home equity calculation is fairly simple. Subtract your current mortgage balance (what you owe) from your home’s current value.

home value – mortgage balance = home equity

Home value $400,000 Mortgage balance $100,000 Home equity $300,000

You can calculate your LTV ratio using the same figures.

(mortgage balance / home value)*100% = LTV ratio

Mortgage balance $100,000 Home value $400,000 LTV ratio 25%

How to take equity out of your house

You have multiple options for tapping your home’s equity.

Type Details Home equity loan With a home equity loan, you receive the entire amount as a lump sum payment. The lender will provide repayment terms set to a fixed interest rate over a specified length of time. A home equity loan is separate from your current mortgage and is often called a “second mortgage.” Home equity line of credit (HELOC) A HELOC is a revolving line of credit, similar to a credit card (but with a much lower interest rate). There’s typically a draw period in which you can borrow as little or as much as you need (up to the limit). Once the draw period ends, the repayment period starts. Cash-out refinance A cash-out refinance is the replacement of your existing mortgage with a new mortgage of higher value. You use the new mortgage to pay off the original mortgage and take the remainder as a lump sum of cash.

There are typically no restrictions on how you use the money you access through home equity. But different options may be better suited to some uses.

For instance, if you’re planning to fund home renovations like a kitchen remodel, have received bids, and know you’re going to need $50,000 to pay the contractor, then a home equity loan or refinance — with a lump sum payment — might make the most sense.

On the other hand, if you plan to make a series of updates and renovations to your home over the course of two years and you’re not sure of the exact amount you’re going to spend, you might appreciate the flexibility of a HELOC.

When in doubt, a loan expert can help you sort through the options and help you determine the best way to tap your home equity.

“Touch base with a professional and trust a professional,” says Bullins. “Call AmeriSave. Call somebody in the business you trust, who knows what they’re doing, and who has experience with mortgages. Go with their advice.”

You should also consult with a certified tax preparer, especially if you plan to use the borrowed money to pay for home improvements. The interest paid may be tax deductible if you use the funds to improve or renovate the home that secures the loan or HELOC.

Using home equity for debt consolidation

After a bit of a dip during the pandemic, Americans’ total credit card debt has again skyrocketed. The New York Federal Reserve reported that credit card balances saw a $38 billion increase in the third quarter of 2022, a 15% year-over-year increase and the largest in two decades!

With credit card interest rates often around 20%, those balances can suck the life out of your finances, strain your budget, and put a damper on your financial and non-financial goals. That’s why many people turn to their home equity to help tackle it. While it’s critical to kick the financial habits that led to the deep debt in the first place, replacing high interest debt from credit cards with a single-digit interest rate home equity loan can save thousands of dollars.

Says Bullins, “Tapping into equity can alleviate pain and fix financial burdens. Generally, it’s a good decision to do it. I think there are very few instances where, if it’s beneficial financially, it doesn’t make sense to do it.”

Pros & cons of taking out equity

While tapping your home’s equity can be an excellent way to get money for your goals, it is an approach that comes with some potential drawbacks. You owe it to yourself to understand the pros and cons, and pursue a home equity loan with “eyes wide open.”

Pros of Home Equity Cons of Home Equity Relatively easy access to significant sums of money to fund home improvement, consolidate debt, or other needs Risk of becoming underwater on your mortgage, which would make your house more difficult to sell Lower interest rates than other forms of lending, such as credit cards or a personal loan Easy access to lending may lead to frivolous spending; you must have good financial habits and a solid repayment plan Easy to qualify, provided you meet your mortgage lender’s basic criteria Risk of foreclosure, as your home is used as collateral Multiple options depending on your needs, including home equity loans, HELOCs, and cash-out refinancing

Considering the stakes (your home is collateral), it’s essential to use your home equity responsibly. “Suppose a borrower uses their equity to consolidate all of their debt,” says Bullins. “Now, this person is debt-free besides their mortgage. But then they slowly start to use credit cards again, plus other revolving accounts and maybe some personal loans. Before they know it, they’re back in the same position they were in two or three years ago. That’s why it’s so important to have solid financial habits in place before you use your home equity.”

How to build home equity

You start building home equity when you buy a home, take out a mortgage, and make a down payment. So let’s say you buy a $400,000 home and make a 20% down payment ($80,000). That $80,000 is your initial amount of home equity.

You can then build equity in three ways.

  1. Make your monthly mortgage payment. Each monthly payment includes both interest and an amount — the principal — that goes toward paying down your mortgage. Each payment of principal adds to your home equity. Once you’ve paid off the mortgage, you’ve reached 100% equity.
  2. Through an increase in your home’s value. While 2022 saw sharp rises in home values in many parts of the country, the historic rate is about 3% per year. So if your home increases in value over 10 years from $400,000 to $450,000, that $50,000 difference adds to your equity.
  3. Improve your home. Any effort to improve your home can add value and increase your equity. These include adding living space, finishing a basement, or updating a kitchen or bathroom.

Another way to understand home equity

Imagine you buy a $400,000 home, and you’re given an empty five-gallon bucket representing the home’s value.

Making a 20% down payment is like pouring the first gallon of water into the bucket. That’s 20% equity!

Making your mortgage payment adds a little bit of water each month. It takes time, but little by little, you build up equity by filling the bucket.

You can also hope to see your home’s value increase over time due to appreciation. A 20% increase in your home’s value, from $400,000 to $480,000, would be like adding a gallon of extra volume to the bucket (now you have a six-gallon bucket). Even better, that extra volume is already filled with water. Not only has your home’s value increased but so has your home equity!

Finally, you can often add to the bucket by improving your home. Finishing your basement, for instance, might add yet another half-gallon of bucket — already filled with water.

Achieve your financial goals with home equity

Like many homeowners, you may have seen your home equity increase significantly in recent months. That equity represents money you can access for a wide range of needs. Used responsibly, home equity loans, lines of credit, and cash-out refinancing can help you achieve your financial goals.

Frequently asked questions: How much equity can I borrow from my home?

What is equity in a home?

Home equity is the value of your home minus the amount you still owe on your current mortgage (the mortgage balance). Expressed as a percentage, equity represents the amount of your home that you truly “own.”

How much equity can I borrow from my home?

Mortgage lenders typically allow borrowers to tap up to 80% of their home equity in the form of a loan, line of credit, or cash-out refinancing. Some lenders allow percentages even higher than 80% for qualifying borrowers.

How soon can you pull equity from your home?

Provided you meet all the other lender requirements, including minimum equity levels and LTV ratio, you may be able to tap your home’s equity as soon as you close on the purchase. Contact your mortgage lender to understand their guidelines.

How long does it take to get a home equity loan?

The approval time for a home equity loan may last anywhere from a couple of weeks to a couple of months. You may be able to help speed up the process by having all your required documentation ready and responding to lender inquiries as quickly as possible.

Is there a minimum for home equity loans?

Home equity loans typically have a $10,000 minimum, according to Experian . However, this varies by mortgage lender.

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