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What Is Tappable Home Equity, and What Are the Best Ways to Access It?
By Martha C. White MONEY RESEARCH COLLECTIVE
Home equity is the value of your property, including appreciation, minus the mortgage balance you still owe. Tappable home equity is the value you can borrow while still preserving at least a 20% equity stake in your home, which lenders typically require. The concept of tappable equity is more important today, given that home prices have skyrocketed, especially in California.
If the market conditions are right — as they have been in recent years — owners typically build equity from the time of their home purchase. In addition to appreciating home values, equity is increased by the amount of the down payment on the property and by any principal that’s paid down through monthly mortgage payments.
Of late, those mortgages have come at near-record low mortgage rates. Real estate data firm Black Knight found that a remarkable 73% of home equity is held by borrowers who are paying less than 4% interest in the second quarter this year.
So how can you best take advantage of the equity in your home and is it safe to do so? Let’s dig in.
How to access your tappable home equity
When you’ve built up sufficient equity to tap, you can borrow from those funds in one of three ways: a cash-out refinance, a home equity loan or a home equity line of credit (HELOC). The equity stays in your house until you access it in one of these ways or until you sell the property.
A cash-out refinance replaces your current mortgage with a new and larger one that covers the home loan, and adds cash that is taken from equity that’s built up for the property. When interest rates are on the rise, though, it’s possible that the new mortgage will have a higher rate than the old one. That makes a cash-out refinance less beneficial, and increases the appeal of the two home equity (also known as second mortgage) options for homeowners who want to tap the equity in their home.
A home equity loan can be adjustable or fixed-rate. A home equity line of credit, often referred to by just its acronym, HELOC, is generally adjustable or variable-rate. However, Michael Popp, senior vice president of SAFE Credit Union in Folsom, California, notes that homeowners might be able to find lower interest rates for a lower monthly payment by seeking out a lender that offers an initial fixed “teaser” rate or the ability for the homeowner to freeze the rate.
Is it safe to draw down tappable equity?
Joe Brancucci, senior vice president and chief lending officer at Financial Partners credit union in Downey, California, says the housing finance market today is far more conservative than it was prior to the subprime crisis that led to waves of foreclosures more than a decade ago. “Before 2008, there was a lot of speculative buying, [and] 2008 was unique. There were a lot of bad mortgages out there.”
Today, mortgage lenders have to follow much more rigorous underwriting standards. For instance, homeowners taking out a new mortgage have to prove that they have the ability to repay the loan amount. Lenders also no longer allow homeowners to borrow the full amount of equity built up in their home.
In the foreclosure crisis that helped trigger the Great Recession, millions of homeowners owed as much — and often more — than their home values. Many of these borrowers simply walked away from their debt, and all those distressed properties had a multiplicative effect. By hurting the values of surrounding homes and, in many cases, entire neighborhoods, the properties helped make the crisis spiral out of control.
How to use your home’s tappable equity wisely
“California has a reputation of using homes like ATMs,” Popp says. “I think the biggest mistake is when [people] use the equity in their home to buy things they wouldn’t be able to afford.”
Popp says smart homeowners can use their tappable equity to help them reach any number of financial goals: Many use the funds for home improvement projects such as a major renovation or expansion that will enhance the value of their property in the future.
Some homeowners use the equity in their homes for debt consolidation. Servicing high-interest credit card debt is getting more expensive. Still, even though the cost of borrowing overall has risen, homeowners can get much better rates by leveraging the collateral in their home. Paying off unsecured debt such as an outstanding credit card balance with a portion of your home’s tappable equity could improve your cash flow situation and maybe even your credit score, to boot.
“Home equity loans are really good to deal with emergencies or make major purchases, but at the same time, they can be a dangerous thing,” Brancucci says. This is particularly true if homeowners rely on the equity built up in their homes to pay for everyday expenses, he adds.
This is a red flag for lenders. “If they’re using it to pay bills, that’s a trigger for us to look at that account and reach out” to the homeowner, Brancucci says.
Summary
- Tappable equity is the equity in your home that you can access and borrow.
- Lenders typically require homeowners to preserve at least a 20% equity stake in their home, so the tappable equity available to you is often the total equity on the property minus that 20%.
- Homeowners build equity over time starting at the home purchase, and when home values go up, equity tends to build more quickly.
- You can tap into your equity through a cash-out refinance, home equity loan or home equity line of credit (HELOC).
- Cash-out refinances tend to become a less common choice when mortgage rates are rising.
- If you choose to use your tappable equity in your house, make sure to do so wisely. Experts warn against using it to buy things you wouldn’t be able to afford otherwise.
- Smart ways to use your home equity include those that help you reach financial goals, like using it on home improvement projects that increase your home’s value. You could also use it for debt consolidation or for emergencies.
