How to Use Your Home Equity

Equity vs. down payment

Your down payment is the chunk payment made at the initial purchase of the home. The size of the down payment depends primarily on the type of loan and the intended use for the property. If you buy a house as a rental property, for instance, you’ll likely pay a larger down payment than if you purchase the same house as a primary residence. Regardless of the size of the down payment, it secures equity up-front, immediately giving you ownership interest as you pay back your mortgage loan.

Once a lender approves your loan, you’ll start making payments on the mortgage. As you make payments, you slowly build more equity in the home until you sell the home, or decide to use it another way. Thus, your down payment is the start of the home equity cycle. Your down payment becomes equity, and once you’ve owned your first home, your equity will likely be your next down payment.

How to build equity

Each monthly payment has a portion of the money going toward principal. So, the simplest, most consistent and reliable way to build equity is through on-time mortgage payments. Sometimes, however, an equity gain occurs in chunks.

This typically happens for one of two reasons:

• You made a large payment toward your principal. No matter where the money comes from, once you put it toward your principal, that money secures as equity.
• Depending on recent market activity – either generally or locally – you may experience a large and sudden increase in your home’s value. This immediately builds equity because equity is a comparison of the principal balance left on your mortgage compared to your home’s value. If your principal balance does not change and your home value appreciates, your equity will increase with your home value.

How do I access my home's equity?

If you’re like most people, there will be a point you think about using your equity. You have a few options to access equity in your home. Two common options include a home equity line of credit (HELOC) and a cash-out refinance. One major consideration, and limitation, when pulling home equity is your final loan-to-value ratio (LTV). This includes the amount on your current loan and the amount added by the new loan. Your LTV is the comparison of the value of the home to what is owed on it.  

Home Equity Line of Credit (HELOC)

A HELOC is a revolving line of credit that uses your home equity as collateral. HELOCs typically allow up to 90% LTV and come with a draw period followed by a repayment period; tending toward 10 and 20 years, respectively. HELOCs are an open line of credit, which allows you to take what you need when you need it. You will usually find variable rates on HELOCs, meaning the rate may change based on an index. You may, however, find a fixed-rate product. Depending on the exact terms of the HELOC, you could see your rates changing regularly or remaining consistent. Regardless of the rate, a HELOC will result in a new monthly payment and add another lienholder to your property.

Cash-out refinance

A cash-out refinance pays off your existing mortgage and borrows a little more against the equity in your home. A mortgage with cash-out replaces your primary mortgage, meaning you will not be adding another lienholder to the property like you would with a HELOC. It also means you can choose from primary mortgage rate options. Speak with your lender to determine the best loan terms for your situation.

A cash-out pays a lump sum. The money from the new mortgage will go toward paying off current mortgage and any other mortgage costs or prepaids with the remaining funds going to you, to do with as you wish. The total loan amount on a cash-out refinance is usually capped at 80% loan-to-value (LTV) on primary residences. This means that if you have a house worth $400,000, your total loan amount cannot exceed $320,000, including everything.  

Which is better?

A cash-out refinance and a HELOC have their benefits depending on the situation. The most important consideration is what you would like to use the money for. If you are consolidating debt or need a large sum of cash to put toward retirement or a college savings fund, a cash-out refinance is likely your best option.

In terms of home renovation, the type of project should be considered. If you have a single project with a well-defined scope, a cash-out refinance should probably be your first choice. HELOCs, on the other hand, are great for ongoing projects or projects that are not as well defined in scope. For instance, if you are renovating an old home or multiple rooms where each project may uncover something new, it could be a good idea to have an open line.

Closing Costs

HELOCs usually come with little or no closing costs. This, along with the fact that you don’t have to draw on it to keep it, results in many homeowners having a HELOC on their home just in case. Cash-outs tend to come with a one-time fee and, depending on the lender, may come with other closing costs common to originating and underwriting a new loan. This is because they are technically a refinance, just one that benefits you extra funds on top. Like any other refinance, you can limit the costs by finding a Zero Closing Cost lender.

CapCenter still covers all traditional closing costs on a cash-out, which allows you to benefit more of your home equity compared to other lenders. There will, however, be a small cash-out fee depending on your final LTV, property type and type of loan. You can get an idea what a cash-out with CapCenter would look like using our free online calculator!

*CapCenter does not currently offer a Home Equity Line of Credit (HELOC) product.