The best way to tap home equity, now that the Fed’s cut rates

Back in September 2024, the Federal Reserve finally began to lower interest rates and continued the cuts at its November and December meetings. HELOC rates have fallen in response. In fact, borrowing against your home’s value hasn’t been this affordable in about a year.  People are paying attention. Mortgage holders collectively withdrew about $48 billion of their home equity in the third quarter of 2024 —  the largest sum in two years.

Ways to tap your home’s equity

There are three main ways to access equity and turn it into cash: home equity lines of credit (HELOCs), home equity loans, and cash-out refinance. All are home-secured debts — that is, they’re backed by an asset (namely, your residence). All can be good sources if you need significant sums: a five-figure amount, at least.

The cash-out refinance is essentially a mortgage with benefits. You’d replace your current mortgage with it. The other two are loans that you could take out in addition to your primary mortgage.

HELOCs: overview

A HELOC is a revolving, open line of credit at your disposal, which functions much like a credit card — you can use it as needed, repaying and then borrowing again. However, a HELOC has some benefits over credit cards.  HELOCs generally have a variable interest rate and an initial draw period, which can last as long as 10 years. During that time, you can take out funds and make interest-only payments. Once the initial draw period ends, there’s a repayment period, during which interest and principal are repaid for 10 to 20 more years.  With a line of credit, however, it can be easy to get in over your head, using more money than you really need to use or are prepared to pay back. The changes in payment amounts can also be challenging to keep up with.

When should I choose a HELOC?

  • You draw at your own pace: HELOCs let you take out cash multiple times, on an as-needed basis. Home equity loans and cash-out refinancing only offer lump sums.
  • You can make a second payment each month: You can have a HELOC in addition to your current mortgage, so you’ll need to be able to afford an extra monthly bill.
  • You don’t mind a variable interest rate: The interest rate on HELOCs fluctuates, which means the rate could rise. Only consider a HELOC if you’re able to handle that.

Home equity loans: overview

A home equity loan allows you to borrow funds in a lump sum. The money is repaid over a set period typically ranging from five to 30 years, at a fixed interest rate.

However, you typically end up paying a higher interest rate for a home equity loan than for a mortgage.  This is essentially a second mortgage.

When should I choose a home equity loan?

  • You want predictable monthly payments: As with your primary mortgage, the same amount is due each month, for the lifespan of the loan. “It’s particularly favorable for borrowers looking to avoid market fluctuations that could increase repayment costs over time,” says Choate. “With rates now more attractive, this option serves well for substantial one-time expenses like home renovations or debt consolidation.
  • You can afford a second mortgage payment each month: Taking out a home equity loan means you will be making two monthly home loan payments: one for your original mortgage and one for your new equity loan. Before you sign on the dotted line, crunch the numbers to be sure you can actually afford the additional payment.
  • You don’t want to change the terms of your mortgage: A home equity loan exists side-by-side with your mortgage, and doesn’t affect it in any way. Aside from using the same property as collateral, it’s a separate animal. In contrast, a cash-out refinance replaces your existing mortgage with a new one, resetting your mortgage term in the process, which might not be ideal for everyone.

Cash-out refinance: overview

A cash out refinance is an entirely new loan that replaces your existing mortgage with a larger one. You receive the difference in a lump sum of cash when the new loan closes.

The cash-out refinance is essentially a mortgage with benefits: You’d replace your current mortgage with it. In contrast, home equity loans and HELOCs are debts in addition to your primary mortgage.  A major downside, however: If rates have increased since you took out your original mortgage, you could pay more interest over the life of the loan.

When should I choose a cash-out refinance?

  • You want to improve your mortgage terms: If interest rates have declined since you initiated your mortgage, a cash-out refinance could allow you to obtain a better rate. You can also extend or shorten the time span of your mortgage.
  • You like to keep it simple: With a cash-out refinance, the mortgage payments and the loan payments are all in one —you’re repaying both simultaneously. HELOCs and home equity loans would be separate, additional payments to keep track of.
  • You need stability in your budget: With a HELOC, your monthly payments can vary substantially, particularly when you transition from lower interest only payment to the repayment period, when you must pay back the principal as well. A cash-out refinance offers long-term, fixed-rate financing, at a rate that’s lower than those of home equity loans.