Home equity
Understanding home equity
What it is, and what borrowing against it really means
12 min workbook
Why this matters
Home equity is one of the most talked-about and least explained parts of homeownership.
Understanding it well protects you from decisions that look simple and are not.
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What home equity is
Home equity is generally the difference between what a home is worth and what is owed against it.
Example: a home valued at $350,000 with a $220,000 mortgage balance has roughly $130,000 in gross equity.
Equity is not the same as available funds
Gross equity is not necessarily the amount that could be borrowed. Loan program limits, other liens, credit, income, property type and lender requirements all affect what is possible.
Estimate my equity
An estimate only. A lender or appraiser determines actual value.
Common ways people access equity
- HELOC
- A home equity line of credit, typically a revolving line secured by the home. Rates are often variable and payments can change.
- Home equity loan
- A loan secured by the home, commonly with a fixed amount and a set repayment term.
- Cash-out refinance
- Replacing the existing mortgage with a new, larger loan and receiving the difference, subject to program terms.
The risk that matters most
Borrowing against a home converts the home into collateral. If the loan is not repaid according to its terms, the home may be at risk. This is true of a HELOC, a home equity loan and a cash-out refinance.
Equity and debt consolidation
You may have heard that using home equity to pay off credit cards is an obvious win. It isn't obvious, and WORKWELL won't tell you to do it.
What matters is understanding the full picture before deciding anything.
What to understand first
- The total cost of borrowing, not just the monthly payment
- The repayment period, which may be much longer than the debt being repaid
- Fees and closing costs
- Whether the rate is variable or fixed
- How payments could change over time
- Whether total debt is actually being reduced or simply moved
- The risk of securing previously unsecured debt against the home
The tax myth
What you've heard
“Home equity interest is always tax deductible.”
What you should know
Deductibility depends on the rules in effect and how the funds are used. Guidance has tied deductibility of home equity interest to funds used to buy, build or substantially improve the qualified home that secures the loan. Individual tax situations vary and a qualified tax professional should address them.
Questions to work through before borrowing
- What is the purpose of the funds?
- Is this a need or a preference?
- What is the total cost over the life of the loan?
- Could the payment change?
- What happens if income changes?
- Am I solving the underlying issue, or repeating it?
- What alternatives have I considered?
A HELOC can also complicate a later refinance of the first mortgage, because the line may need to be subordinated or paid off. Worth knowing before you open one.
Where am I today?
Start here
Estimate your equity with the worksheet above, then write down the purpose you would be borrowing for.
If the purpose isn't clear on paper, it isn't clear yet.
30-day WORKWELL challenge
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Your next step
Equity decisions are rarely urgent, even when they're presented that way. Take the time to work through the questions.
If you'd like to talk through your options with someone who isn't selling a loan, that's what WORKWELL is for.