If you’re a homeowner who has heard the phrase ‘home equity’ but only kinda sorta knows how it works, you’re not alone … and you’re likely not capitalizing on your home’s potential. Equity is powerful — it can help you fund your next major milestone, consolidate debt, and sidestep financial emergencies. But only if you know how to use it.
Here’s everything you need to know about your home’s equity, and more importantly, how to use it to your advantage.
Home Equity at a Glance
Home equity is the money you’d make from selling your house after paying any debts. It’s essentially the part of your home’s value that you’ve already paid off.
To convert your equity’s value into cash, you need to take out a loan: a home equity loan, HELOC, or cash-out refinance. Generally, lenders will give you a loan that equals up to 80 percent of your existing equity.
To get more home equity, make regular mortgage payments and increase the value of your home (usually through renovations or patience with the housing market – you pick).
A home equity loan transforms your equity into one lump sum with a fixed rate and fixed term. It tends to work best for people who like extra stability or plan on only spending their equity once.
A HELOC transforms your equity into a credit balance, which you can spend much like a credit card. You only pay back what you spend, plus interest. It tends to work best for people who prefer flexibility or anticipate making several smaller purchases with their equity over time.
A cash-out refinance lets you access your equity by taking out a bigger mortgage with a higher monthly payment. It tends to work best when housing interest rates drop below your mortgage’s current rate.
What is home equity?
Home equity is the potential profit you’d make from selling your house. It’s the difference between the market value of your home and what you still owe on your mortgage. In other words, it’s the part of your home that you actually own.
Example: You have a home that is valued at $400,000, and you need to pay off $250,000 of your home mortgage. That means you likely have $150,000 in equity.(400,000 – 250,000 = 150,000.)
As you make payments or your property appreciates, your equity grows, which gives you more potential funds for borrowing or investing.
Without a loan, that equity sits untouched and out of reach until you sell your home and buy another. When you do, you can roll the profit you made from the first house (aka your equity) into the second, making your new home cheaper.
Your equity doesn’t automatically equal cold hard cash, though. To convert that equity into money before you sell your house, you need a lender. They’ll use your equity as collateral to give you a loan.
Because there’s collateral, these loans typically have lower interest rates than, say, a credit card. It also means that if you default on your payments, your home could be on the line.
Why do I need a loan to access my equity?
To make this concept a little simpler, let’s pretend your home is an old dresser. (Bear with us here.)
Say you bought a dresser for $1,000. After refinishing the wood, replacing the hardware, and adding your own artistic flair, you’re confident you can sell the piece for $3,000. Exciting! Of course, you only get that money if you actually sell it.
But what if you want to access the anticipated $2,000 profit before you sell the dresser? Because the profit is only potential money right now, you need someone who’s willing to loan you those funds. If you don’t pay them back, they’re allowed to take the dresser to recoup their loss.
Now let’s translate this into home terms. Equity is akin to your home’s potential profit. If you want to access that potential money before selling it, you need someone who’s willing to take a risk and loan that money to you now. To make the risk worth it for the lender, they need to know they can use your house as collateral if you don’t pay them back.
How do I build home equity?
Equity is a crucial part of homeownership, but it’s one that many don’t consider when creating a financial strategy simply because they don’t know how to make their equity work for them.
To build equity, use one (or both) of these strategies:
- Make regular mortgage payments. The less money you owe, the more equity you have. As you make payments toward your principal balance (the part of your loan that isn’t interest), that money comes back to you in the form of equity.
- Increase the value of your home. A property’s value can grow or shrink over time, depending on factors like the housing market and neighborhood development. While you may not be able to control the housing market, you can increase the value of your home by completing home renovations. Some renovations translate to value better than others, so be sure to research which upgrades will give you the most bang for your buck.
How do I access my equity?
There are three answers: a home equity loan, a HELOC, and a cash-out refinance.
How does a home equity loan work?
When you take out a home equity loan, your lender gives you a lump sum (usually around 80 percent of your equity) to spend as you wish. It has a fixed rate and term, which guarantees you consistent monthly payments.
Because borrowers receive their funds all at once and at a fixed rate, home equity loans tend to work best for people who are looking for a lower-risk, one-time financing option. Compared to other options, they have clear repayment terms and amounts, and the fixed rate protects you against market fluctuations.
How does a HELOC work?
A HELOC, also known as a Home Equity Line of Credit, acts more like a credit card than a standard loan. Your lender gives you a credit balance (again, usually about 80 percent of your equity), which you can spend however you like. You only pay back what you spend — plus interest — at a variable rate. Term length varies by lender, but at ICCU, a HELOC’s term is 10 years.*
Unlike a credit card, a HELOC has two different payment phases:
- The draw period: A 10-year phase when you can repeatedly withdraw funds and make interest-only monthly payments. You only pay interest on the withdrawn amount, not the entire available balance. We recommend making additional payments on the principal when possible so you owe less during the repayment period.
- The repayment period: The timeframe after the draw period when you repay the rest of your loan. Lenders organize the repayment period differently. ICCU requires a one-time balloon payment, which means your remaining balance is due immediately after the draw period ends.
(Want to learn more about HELOC requirements and the best ways to use one? See our in-depth HELOC guide.)
HELOCs often work best for people who need flexibility. If you’re unsure how much equity you’ll need to spend or want cash on hand frequently, a HELOC might be the right choice for you. Keep in mind that with added flexibility comes added risk; your monthly payment will vary depending on interest rate changes and how much you spend.
How does a cash-out refinance work?
A cash-out refinance allows you to replace your current home loan with a larger one. Because you’re borrowing more than what you owe on your mortgage, you receive the extra funds in cash.
Typically, people refinance their mortgage to get a better interest rate, lower their monthly payments, or change their loan’s term length — but they never see any cash. A cash-out refinance, on the other hand, increases your mortgage’s balance and monthly payment so you can access your equity as cash after closing.
While a home equity loan and a HELOC are considered second mortgages, a cash-out refinance isn’t. That’s because you still only have one mortgage; it just comes at a higher monthly payment than it used to.
To be successful with a cash-out refinance, you need to balance your cash needs with your ability to pay down a larger mortgage every month. It tends to work best when housing interest rates drop below your mortgage’s current rate. That way, you’re still improving part of your existing home loan, even as you increase your monthly payment.
How do I choose the right loan?
Each loan has its strengths and weaknesses. The trick is finding one that complements your strengths and weaknesses as a borrower. If you know you struggle to manage a credit card responsibly, for example, a HELOC might not be the right choice for you. But if you’ve already locked down your credit card strategy and your budget needs a dash of extra cash and flexibility, a HELOC might be the perfect fit.
That’s true of home equity loans and cash-out refinances, too. Each has pros and cons. Choose the one that meets your needs best and helps you avoid the risk of missed payments.
If you’re not sure where to start, browse our Home Equity page or speak to an ICCU team member today to get qualification details and personalized recommendations.
Disclosures
*10-Year Draw Period
Variable-rate APR will be updated monthly based on the index and margin associated with your plan. Rate will never be below 3.25% APR or above 24.00% APR. To view current APR, click here. Fees payable to third parties may be collected up front and may include borrower-requested appraisals or vesting changes via quit claim deed. Fees may range from $0 – $1,000. Property insurance required. Exact rate dependent on creditworthiness. Rates as of 03/10/2025.
