The easiest way for homeowners to access the equity they've built up is to sell their home. You receive the purchase price minus your outstanding mortgage balance and any seller's closing costs.
But if you don't want to move, and still want to convert your equity to cash, one way to do it would be with what's known as a cash-out refinance. You'd sign up for a new mortgage, use it to pay off what's left of the old one, and pocket the difference. Or you could sign on for a home equity loan or line of credit.
They're tempting options when mortgage interest rates are low. But should you tap into your home equity?
Paying off other debt is a common use of funds from a cash-out refinance or even a home equity loan or line of credit. If you can get a new loan at a lower rate, and you're paying off high-interest debts like credit cards or personal loans, it makes financial sense to use the low-interest cash to pay off the high-interest balances.
Similarly, it might make sense to cash in some equity to start an emergency fund or to invest. An emergency fund can help you guard against large, unexpected expenses that can destroy a household's finances, and it might cost you very little in interest to establish it.
On the flip side, taking the cash and splurging on a vacation or something else you instead could save up for means paying more for it. That trip abroad or pair of jet skis costs more each month if you borrow against your home to pay for it.
Before taking out home equity, it makes sense to see how using it makes, saves, or costs you more money.
Can you add value?
Another common use of cash drawn from a home's equity is remodeling or renovations to the home. And some home improvement projects can add substantial value to a property.
Finishing a basement or putting on an addition adds living space to a home, which almost always increases its market value. If you use some of your home equity to pay for improvements that increase its worth, you stand to recoup at least some of the cost when you sell.
This scenario can especially make sense when there are updates or upgrades that are necessary for a home to reach its top-end market value. For example, if every home in your neighborhood has all hardwood floors, and you have carpeting throughout, your home is unlikely to sell for what it could if it was in line with the rest of the area. What you pay in interest can often be recovered in your eventual sales price if the home appreciates appropriately with the new improvement.
You're basically reinvesting some equity with the hopes of adding more equity.
Can you afford it each month?
No matter how much overall financial sense it might make, paying down other debt or doing work on your home can be counterproductive if you can't afford your new monthly payment.
If you're refinancing to a much lower rate or extending the length of your loan, your payment might not be very different. But if it's tough to make ends meet each month now, does it make sense to add a new loan payment to your monthly fixed expenses?
The bottom line
Every homeowner's situation is different, and how you access the funds matters, but if you're considering taking cash out of your home's equity, do the math, examine what you're using the money for, and make sure you can afford the monthly expense.