Keep in mind, equity is not liquid wealth. You typically have to take out a loan to access it (more details on that below).

But if you have enough equity, there are ways you can actively use it to your advantage.

Some of the biggest ways homeowners benefit from their equity include:

1. The ability to borrow large sums of money from your equity at a very low interest rate, perhaps for emergencies or large expenses like home renovations
2. Using equity as leverage to lower your mortgage costs. Homeowners who build up enough equity can get rid of private mortgage insurance (PMI) and sometimes refinance into a lower interest rate
3. Increasing your profits when you sell the home. The more equity you have, the more money you’ll make when you eventually sell. This can be a key asset for homeowners moving to a new home or downsizing in retirement

Borrowing large sums from your equity

One of the key benefits of building home equity is that you’re creating a pool of wealth from which you can borrow.

When you borrow money from your equity, the loan is secured by your home (just like your original mortgage). That means home equity borrowing has far lower interest rates than other sources of money, like credit cards or personal loans.

For homeowners with enough equity built up, this is often the cheapest way to finance big expenses like:

• Home renovations, remodeling, or repairs
• Buying a second home or investment property
• Large, unexpected medical expenses
• Paying college tuition for yourself or a child
• Consolidating high-interest debts that are costing you a lot in interest
• Starting up a small business
• Creating an emergency fund

Of course, home equity borrowing isn’t a free ride. You’re still borrowing from a mortgage lender, even though it feels like you’re borrowing from yourself. That means you’ll pay interest on the loan. And ultimately, you’re increasing your debt and reducing your net worth.

So it’s best to do this only when necessary; for instance, if you have a huge and unexpected medical bill, or you’re starting a new, surefire company or you’ve built up a pile of expensive debts and need to consolidate them.

By the way, federal regulator the Consumer Financial Protection Bureau warns against “borrowing against your home as part of an investment strategy.”

Canceling mortgage insurance

Many homeowners find private mortgage insurance (PMI) a real burden.

Paying PMI on a conventional loan — or mortgage insurance premiums (MIP) on an FHA loan — can easily add hundreds of dollars to your monthly mortgage payment.

The good news for homeowners with conventional loans is that they can stop paying PMI once their equity hits 20%. You simply call your mortgage loan servicer and ask to have it removed.

But that rule doesn’t apply to FHA loans.

What FHA homeowners do once they have 20% equity is refinance to a conventional loan without PMI.

Their 20% equity counts as a 20% down payment, putting them over the threshold where mortgage insurance is no longer required.

Getting a lower mortgage rate when refinancing

When lenders look at any mortgage application, they focus on three main things:

1. Your credit score
2. Your debt-to-income ratio (DTI)
3. Your loan-to-value ratio (LTV)

Lenders will adjust the mortgage rate you’re quoted to reflect how you measure up against those criteria.

The more home equity you have when you refinance, the lower your loan-to-value ratio. This is a good thing in lenders’ eyes because it decreases your risk as a borrower, and you’ll likely be offered a lower mortgage rate.

And, of course, if you managed to boost your credit score and pay down some of your debts in the meantime, that rate could be ultra-low.

Increased profits when you sell your home

Home equity can also act as a nest egg for your future life, helping you save money for when you move or retire.

When you sell your home, part of the proceeds are used to pay off your remaining mortgage balance. The less you owe on your mortgage, and the more equity you have when you sell, the more money you’ll get to keep from the sale.

These funds can be used to make a down payment on your next home, or in some cases even buy the property outright with cash.

For retirees downsizing to a smaller home or retirement community with lower housing costs, cashing-out home equity when they sell can also provide lump sum for living expenses.

1. Cash-out refinance — You get a new mortgage with a larger loan amount to replace your existing mortgage, and you walk away with a check for the difference. Typically these have the highest closing costs but the lowest mortgage rates
2. Home equity loan (HEL) — You borrow a lump sum as a second mortgage. You pay it back, usually at a fixed interest rate, over a set period of time. This is a second monthly payment your primary mortgage payments
3. Home equity line of credit (HELOC) — This is a bit like a credit card. You get a credit limit you can borrow against, pay back, and reborrow as often as you want within a certain time frame (the ‘draw period’). HELOCs typically have variable interest rates that are much, much lower than credit cards. But these loans are complicated so make sure you fully understand them before you commit

There are other ways in which you can tap your equity, too.

For example, you can borrow for home improvements using an FHA 203k home purchase loan or refinance. Or, if you are 62 years or older, you can explore reverse mortgages, which provide cash but roll up interest and loan costs so you pay nothing until you move or pass away.

It’s important to recognize that all of these loans — including HELs and HELOCs, which are ‘second mortgages’ — are secured loans. You’re using your home as collateral. So, if you fall too far behind on payments for any of them, you could face foreclosure.

Home equity loan, HELOC, or cash-out refinance: Which is right for you?

Choosing between a cash-out refinance, home equity loan, or home equity line of credit is something you want to get right. So be sure to read about them each in-depth. See:

• What are the benefits of a cash-out refinance?
• HELOC vs. home equity loan: Which is right for you?
• Cash-out refinance vs home equity loan

We don’t have space here to tell you all you need to know. But here are some of the most important characteristics of these loans:

1. Cash-out refinances tend to have lower rates than HELs or HELOCs, but higher closing costs
2. Home equity lines of credit (HELOCs) often have the lowest upfront fees of the three, and are the most flexible. But they’re also complex and have downsides that sometimes trip up unwary borrowers
3. Home equity loans and HELOCs typically have a shorter repayment period than cash-out refinances, and you’ll have a smaller loan amount meaning you pay less interest
4. You’ll likely pay less interest when you use any of these products to borrow a large amount than you would using a loan that is not secured by your home, such as a personal loan
5. But personal loans have lower (or often zero) closing costs. So they may be better when you want to borrow smaller sums
6. You need to shop around for the best deal with all these products. Offers vary widely and you could save thousands by seeking out the right lender for you
7. Pay attention to the annual percentage rates (APRs) you’re quoted. These reflect the loan’s costs as well as its interest rate. So they’re often a better guide to value for money

There’s nothing especially scary about tapping your home equity. But it’s a serious business, so do your homework and be sure you’re making the right decision for your personal finances.

The maximum amount you can borrow compared to your home’s value is typically expressed as a maximum ‘loan-to-value ratio,’ or ‘LTV.’

In these terms, the maximum LTV on most cash-out refinance loans is 80%.

Lenders have this rule to lower the risk of borrowers defaulting. But it also adds to your wider financial health.

On the flip side, using your home equity to put your life back on track by consolidating expensive, out-of-control debts is often a very smart move — providing you’ve first consulted a certified financial counselor.

Many people also use home equity for renovations that increase the value of the home. This can benefit you in the long run by netting you a bigger profit when you eventually sell.

The main consideration to keep in mind when borrowing from home equity is that your house is used as collateral.

So if you can’t repay the loan — for instance, if you were to run up debts again and couldn’t afford monthly mortgage payments — you could face foreclosure.

This underscores the importance of tapping home equity only when necessary and using the money for purposes that improve your overall financial situation.