By Elizabeth Lucchesi

Home equity – the market value of your home minus any outstanding mortgage balance – is not just a number. It reflects your net worth and aids financial growth and stability. By leveraging your home’s equity, you can embark on a journey to achieve your financial goals, whether making home improvements, consolidating debt or investing in a second property for a passive income stream.

Home equity is not a static concept. It’s a dynamic asset that grows over time as you pay your mortgage and your property appreciates. Understanding how to access this growing asset is key. According to NerdWallet, you can tap into your home equity through various means, such as home equity loans and lines of credit – also known as HELOCs – and cash-out refinancing. Each option has its pros and cons, but you have the power to choose the one that best aligns with your financial goals and situation.

Home equity loans vs. selling your property

One of the primary decisions homeowners face is whether to tap into their home equity through a loan or sell their property outright. Both options offer distinct benefits and challenges.

Home equity loans and HELOCs allow you to borrow against your home’s equity while retaining ownership. These options are beneficial if you need a lump sum or flexible access to funds. For instance, using a home equity loan for home improvements can increase your property’s value, further enhancing your equity; however, it’s important to remember that these loans use your home as collateral, meaning you risk foreclosure if you fail to make payments.

To put this into perspective, consider a scenario where a homeowner uses a home equity loan to fund a kitchen renovation: the renovation increases the home’s value by $50,000, but they could lose their home if the homeowner fails to make the loan payments.

Selling your home can unlock substantial funds, especially in a seller’s market. This option might be attractive if you’re downsizing, relocating or the home requires extensive repairs; however, selling involves transaction costs, potential capital gains taxes and finding a new living place.

Ways to use home equity

Make improvements. Upgrading your home can create a living space you love and lead to even more equity in the future. Renovations such as kitchen upgrades, bathroom remodels and energy-efficient improvements often provide a high return on investment.

• Consolidate debt. A home equity loan is one way to simplify your finances by consolidating high-interest debt. Your mortgage company sends a check to credit card companies and other debtors. The total amount loaned to you is lumped into a single payment, typically with a lower interest rate.

• Generate passive income. Using home equity to invest in a second property – such as a vacation home or rental property – can diversify your investments and generate passive income.

• Establish an emergency fund. Establishing a HELOC as a safety net can provide peace of mind. Unlike home equity loans, HELOCs offer flexible borrowing and repayment terms, making them suitable for unexpected expenses or emergencies.

Risks and considerations

Leveraging home equity can offer significant benefits but also comes with risks. As with every major life decision, it’s best to understand the risks and move forward once you can make an informed decision.

Market fluctuations

Real estate markets can be volatile. A downturn in the market can decrease your home’s value, reducing your equity. If you’ve borrowed heavily against your home, this could lead to owing more than your home is worth, a situation known as being “underwater,” meaning your mortgage’s outstanding balance is higher than your home’s current market value. This can be a significant financial risk, making it difficult to sell your home or refinance your mortgage. Considering this risk when deciding how much of your home equity to leverage is important.

Foreclosure

Home equity loans and HELOCs use your property as collateral. Failure to make payments as scheduled can result in foreclosure, so know what you can reasonably afford and avoid borrowing more than that amount.

Fees and costs

Accessing home equity often involves various fees, including origination, appraisal and closing costs. These can add up and should be factored into your decision-making process.

Making the decision

Whether to tap into your home equity or sell your home depends on your financial goals, current market conditions and personal circumstances. Here are some steps to guide your decision.

1. Set the expectation. Know what you want to achieve by accessing your home equity. Whether it’s home improvement, debt consolidation or purchasing another property, establishing the end goal will help you choose the right option.

2. Evaluate the market. Consider current real estate market conditions. A seller’s market might make selling your home more attractive, while low interest rates could favor borrowing against your equity.

3. Ask your financial advisor. Get advice from your trusted team – especially a financial professional – to best understand the implications of your choices. These experts can provide insights into the best strategies based on your unique situation.

The bottom line

Accessing your home’s equity can be an intelligent tool to support your financial goals; however, it’s important to remember that these strategies have risks. For example, a downturn in the real estate market could decrease your home’s value and leave you owing more than your home is worth.

Whichever route you take with your home equity, the first step is to evaluate your options and understand potential risks carefully. Informed decisions will help you make the most of your home equity and contribute to a solid financial future.

The writer is the founder of LizLuke Team with more than two decades of experience in the residential real estate industry.