How to safely cash out your home equity windfall

You might not feel it yet, but if you’re an American homeowner, you’re probably a little richer after the skyrocketing rise in house prices last year. But how do you tap into your new found wealth? And should you?

US homeowners gained an average of $55,300 of their home’s value (minus their mortgage) in 2021. In some particularly hot cities, like Denver and Miami, the increase was nearly $80,000, while in Los Angeles and San Francisco, where prices are high, it was over $110,000.

That’s a remarkable jump given that it took three to four years to see gains of $50,000 in previous bull markets, said Frank Nothaft, chief economist at real estate analytics firm CoreLogic.

For anyone who wants to sell, it’s a godsend – just find a buyer and turn that appreciation into cold hard cash. But what if you’re happy to stay put?

With all of the current market volatility, inflation and other economic uncertainties, it’s only natural to want to capitalize on those gains now, perhaps by borrowing against your newly increased equity (the difference between the current value of your home and what you owe on your mortgage.)

Is it safe, however, to use your home as an ATM, especially as fears of a recession loom? It can actually be a smart game, if you use the money wisely and choose the right loan product.

The two main options for tapping into equity are to refinance a mortgage or acquire a home equity line of credit. For the first, you use the higher value of your home to get a larger mortgage at a fixed interest rate, pay off the original smaller loan with the proceeds, and pocket the difference.

But most people who could benefit from such “withdrawal rebates” did so before interest rates started to rise.

So let’s take a closer look at the home equity line of credit. If you’re looking to do home renovations, tapping into your home’s equity can be a prudent way to do it. A line of credit usually makes the most sense because you don’t have to know exactly how much you’re going to spend.

You are allowed to borrow a certain amount at an interest rate that usually floats with the market and then you can withdraw the money as needed. (With a withdrawal refi, you receive a sum of money all at once, whether you plan to use it all or not.)

If you’re in good financial health – that is, you’re doing everything advisors recommend, such as setting aside money for retirement – and you plan to use that money for, for example, improving your home office situation or improving your backyard, go for it. You will create more value in your home and also make your life more enjoyable.

While it’s always scary to borrow against equity that has magically appeared over the past year (could it disappear just as quickly?), take comfort in the fact that – thanks to the housing crisis than 15 years ago – we have a lot more guardrails these days when it comes to borrowing against home equity. Banks limit the amount you can withdraw and they need more documents to be eligible than before.