What can you use a home equity loan for?

Home equity is the portion of your home you’ve paid off — it’s what you outright own. Did you know your home equity doesn’t have to stay locked in your home? You can tap into it with a home equity loan and use it for a variety of reasons. Wondering how to use a home equity loan? We’ve got answers.

What Is home equity?

As you make payments on your mortgage, you’re building home equity — that is, the part of your home that you own. In other words, it’s the difference between the total value of your home and what you still owe.

Your down payment automatically becomes equity. Say for example, you make a 10% down payment on your home that is worth $200,000. This would make your starting equity 10%. From there, your home equity will continue to rise as you pay off the loan.

Home Equity Loans and how they work

Homeowners borrow against their homes to put their equity to good use. A home equity loan is a second mortgage on your property and takes the second lien position to your primary mortgage.

A home equity loan provides a lump sum of cash that borrowers repay at a fixed interest rate. You immediately make principal and interest payments after you close on the loan.

Most home equity loans offer fixed interest rates. Your monthly payments never change for the life of the loan, which can be 10 – 30 years. Rocket Mortgage^® provides home equity loans with 10- and 20-year fixed-rate repayment terms.

Lender programs and terms will vary, so check with your lender to discuss their home equity loan offerings.

An example

Most lenders will allow you to borrow 80% – 85% of the difference between your home’s current market value and the outstanding balance on your first mortgage.

For example, let’s say your home is valued at $300,000. If you borrowed 85% of the home’s value, the maximum loan amount you would qualify for is $255,000. When you factor in the outstanding balance on your first mortgage, which is $150,000, you’re left with $105,000 to borrow with a home equity loan.

We don’t recommend borrowing more than you need. But knowing you can access up to 85% of your home’s value can help in scenarios.

How to calculate home equity

Thankfully, you don’t have to be a math whiz to calculate your home equity. To do so, you’ll only need two key figures and a calculator (physical or mental).

First, find out how much you still owe on your mortgage principal. Next, determine how much your home is worth. If you don’t have an exact figure, try using the sale price of similar homes in your market. Then, subtract the amount you still owe from what your home is worth.

Now, let’s consider a realistic example of how to calculate home equity.

Say you still owe $180,000 on your home, and your home’s total value is $200,000. To calculate your home equity, you’d subtract $180,000 from $200,000 making your home equity $20,000.

Example of calculating home equity

Now, let’s consider a realistic example of how to calculate home equity.

Say you still owe $180,000 on your home, and your home’s total value is $200,000.

To calculate your home equity, you’d subtract $180,000 from $200,000. This would mean your home equity is $20,000.

3 Alternative ways to take equity out of your home

 Taking equity out of your home requires that you borrow against your equity. In other words, you’ll be borrowing from the part of your home that you own. Keep in mind, though, that your home will serve as collateral for the loan.

There are three common ways to use your home equity: HELOCs, reverse mortgage and cash-out refinance. Let’s take a deeper dive into each home equity loan option.

1. Home Equity Line Of Credit

A home equity line of credit, or HELOC, allows you to borrow from your home equity similar to the way you use a credit card.

Corresponding to the amount of equity you have, you can draw from a line of credit as needed – so long as you repay in full by the end of the draw period. After your draw period ends, you’ll be charged interest on any money you still owe. Your unique draw period is set by your lender, but they’re typically anywhere from 5 to 15 years.

2. Reverse mortgage

Homeowners who are 62 or older also have the option of a reverse mortgage, which makes it possible to turn home equity into extra income for retirement. This type of home equity loan doesn’t require seniors to make monthly mortgage payments or sell their home.

A reverse mortgage is often ideal for homeowners who don’t ever plan to sell their home and aren’t looking to leave an inheritance behind. 

At present, Rocket Mortgage does not offer reverse mortgages.

3. Cash-out refinance

A cash-out refinance replaces your current mortgage with a new one of a higher amount. You can then receive the difference between the two loans in cash. Refinancing your mortgage usually takes 30 – 45 days. You’ll then continue to pay down just one mortgage monthly, only with a higher balance than before.

For a cash-out refinance, you’ll typically have to leave at least 20% equity in your home.

Pros and cons of using a Home Equity Loan

Depending on your unique situation, taking out a home equity loan could either be a wise financial investment or a costly liability. So, it’s very important to carefully consider the pros and cons of using your home equity.

Potential benefits of a home equity loan include:

• Fixed interest rate
• Predictable monthly payments
• Longer repayment periods
• Relatively low interest rates compared to personal loans or credit cards
• Possible tax benefits

Potential drawbacks of a home equity loan include:

• Possible foreclosure if the loan isn’t repaid
• Your fixed interest rate remains even if interest rates go down
• Significant debt if loan isn’t properly managed
• 20% minimum equity and “good” credit score required
• Threat of negative equity

7 common reasons to borrow against home equity

There isn’t a right or wrong way to use your home equity loan. You earned the equity in your home and can use it how you want. However, the money you withdraw from your home is a loan, and you must pay it back with interest.

Before tapping into your home equity, make sure you can afford the monthly payments and that the reason you’re taking out the loan justifies the interest you’ll pay. If you want to pay less interest, it’s best to request the shortest term you can afford.

1. Consolidating debt

Debt consolidation is a popular reason to get a home equity loan. When you consolidate debt, you use the loan to pay off your existing debts. You can pay off the balances yourself or work with your lender to have them disburse funds directly to your creditors.

When you consolidate debt, you simplify bill payments by combining all your debts into a single loan. You’ll have one loan payment to make each month rather than multiple bill payments. And you may have a lower interest rate compared to your existing debts.

Consolidating your debts into one easy-to-manage loan should help make budgeting and getting out of debt much easier and faster.

2. Remodeling your home

After debt consolidation, home renovations or remodeling is the most popular reason to take out a home equity loan.

It’s also one of the most financially savvy reasons to tap into your home’s equity. When you finance home improvements, you invest in your home. You withdraw money from your home to boost its value and resale amount. Not every home improvement will increase your home’s value dollar-for-dollar, but you’ll typically see some appreciation.

Because home equity loans provide lump-sum payments, it’s crucial to know how much the home renovations will cost before you apply. Finally, if you itemize deductions on your taxes and use the money to make home improvements or renovations, you may be able to deduct the interest you pay on the home equity loan.

3. Buying investment property

Using your home equity to buy an investment property can be another valuable way to use your funds. However, financing an investment property or vacation home purchase can be challenging because it isn’t a primary residence, and lenders typically require higher down payments for investment properties.

If you don’t have the capital upfront, that will delay your purchase. You can use the equity in your home to make a larger down payment on an investment property or vacation home.

4. Paying for college

If you don’t want your child to take out student loans but financial aid doesn’t cover their college costs, you can use the equity in your home to fund their higher education.

A home equity loan is typically a good idea when mortgage interest rates are lower than student loan rates. While federal student loan rates can be competitive, private student loan rates can get high. A home equity loan may offer a lower interest rate and help you save money on college costs.

Home equity loans don’t offer special repayment programs or assistance. If you struggle to repay the loan, you won’t qualify for federal student loan debt relief, and you may lose your home if you default on the loan.

5. Building an emergency fund

If you don’t have an emergency fund, consider tapping into your home’s equity to create one. Ideally, your emergency fund should be able to cover 3 – 6 months of expenses.

If you use your home equity to build an emergency fund, invest it somewhere safe, such as a CD or another interest-bearing account. You should only use the funds for legitimate emergencies.

6. Becoming a business owner

Starting a business can help you achieve financial freedom. However, not all aspiring entrepreneurs have the capital to fund their dream of becoming their own boss.

With a home equity loan, you can get the necessary capital without paying high interest rates or jumping through hoops for loan approval. Many brand-new business owners don’t qualify for a business loan because they haven’t established a business history. A home equity loan can bridge that gap and finance various expenses such as equipment, a security deposit for a building, or marketing.

Typically, new business owners who can’t take out a home equity loan take out a personal loan or pay for everything with high-interest credit cards, which may strain their finances and potentially hinder a business’s ability to grow.

7. Investing in yourself

One of the best investments you can make is in yourself. If your career requires continuing education courses or a return to school may increase your chances of getting a better job, a home equity loan can help you cover the costs.

You don’t have to put off professional development. You can invest in yourself and increase your chances of making more money. Use your raise or higher income to pay off your home equity loan early and maximize the benefits of investing in yourself.

What shouldn’t you use a Home Equity Loan for?

Most lenders don’t restrict or ask how you plan to use your home equity loan funds. However, you should be very careful about your reason for taking out a home equity loan, especially if you’re borrowing against your home to:

• Buy a car: While it’s not encouraged, you should only use a home equity loan to buy a car if you understand the cost of the loan and can afford it without putting your home at risk.
• Fund a wedding: Weddings are expensive, but covering the costs of that single day with the funds you’ve built up in your home – likely your largest asset – isn’t a good long-term use of the money.
• Make a risky investment: Your home equity is a valuable asset. Risking it on the chance that you might earn high returns can be dangerous. Even if someone promises you the investment is a sure bet, you should exercise extreme caution.

Ways to increase your equity

If you plan on taking out a home equity loan in the future, building more equity in the meantime can allow you to borrow more when the time comes. Consider implementing one of the follow strategies to increase your home’s equity:

• Make a large down payment
• Make biweekly mortgage payments instead of monthly
• Remove your private mortgage insurance plan
• Invest in equity-boosting home renovation projects
• Shop around for the best loan terms
• Refinance to a shorter loan term
• Wait for your home’s value to increase on its own
• Put any extra money towards your mortgage

The bottom line on how to use home equity

Having enough equity in your home and meeting a lender's home equity loan requirements is half of the equation. The other half is carefully evaluating your reason for getting the loan. Whether you want to invest in yourself, finance home improvements or consolidate debt, there are many valid reasons to access home equity with a home equity loan.

The loan should help you achieve your present and long-term financial goals. And you should only borrow what you can afford so the loan doesn’t strain your budget.

A home equity loan can be a powerful tool when it aligns with your goals. If you’re ready, start an application online and see what you qualify for.