Unlocking Home Equity: Smart Strategies When You Are House Rich but Cash Poor

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When I bought my house in 2016, I had a good job with solid benefits, one child and a mortgage interest rate of around 3%. It cost me $171 per square foot to buy the waterfront property in the Colorado mountains.

Now, I'm employed as a freelancer, managing my own benefits with two kids. Mortgage rates are double what they were eight years ago, and the cost of living is 31% higher, according to SmartAsset's inflation calculator. The price-per-square-foot value of my home is nearly $293.

It's called being house-rich and cash-poor. Many homeowners are in a similar situation, with plenty of home equity. As wages have not kept pace with the rising cost of living, they have less income to pay for their mortgage and everything else.

Homeownership is a tool for wealth-building, not just as a long-term asset but also for accessing cash in the here and now. You can leverage your home equity if you need to borrow money to finance a project or take out a low-interest loan to consolidate debt.

Here are some options for unlocking your home equity, along with the risks and possible rewards associated with each option.

Ways to leverage your home equity for cash

What's a home equity line of credit and how does it work?

A home equity line of credit is a loan determined by the amount of equity you've accrued from your home, which can be used to pay for expenses over a certain period. Like a credit card, it gives you access to an amount of credit that you can use to pay for just about anything. With most HELOCs, you'll have a set amount of time to use the money before you enter a repayment period. At that point, you'll start making monthly payments (with interest) on the credit you used.

HELOC interest rates are typically lower than the current market credit card interest rates. But unlike a credit card, a HELOC is secured by your personal property. If you stop making payments on the HELOC, you're at risk of losing your house.

Requirements for a HELOC:

15% or more equity in the house
A credit score of at least 620, though 700 is preferable
Verifiable income
A 43% (or lower) debt-to-income ratio, meaning that your monthly debts are equal to or less than 43% of your monthly income

Potential risks of a HELOC:

Your home is collateral, so you risk losing it if you can't make payments
You could end up "upside-down" on your mortgage if home prices change, meaning you owe more on the house than it's currently worth
Interest rates on HELOCs are variable, so they will fluctuate over time
While you'll be given a cap on the amount you can borrow, you might end up spending more than you originally intended to

What's a home equity loan and how does it work?

A home equity loan is a loan secured by the accrued equity in a home. Like with a HELOC, if you stop making payments on a home equity loan, you risk losing your house.

Unlike a HELOC, you'll get a lump sum of money instead of a line of credit, and the interest rate is fixed, so it won't change over time. The rates are also typically lower than current credit-card interest rates, and the interest can be tax deductible when used for home renovations or improvements. Home equity loan repayment usually starts immediately, which means an additional debt you'll have to start paying off on a monthly basis.

Requirements for a home equity loan:

15% or more equity in the house
A credit score of at least 620, although 700 is preferable
Verifiable income
A 43% (or lower) debt-to-income ratio, meaning that your monthly debts are equal to or less than 43% of your monthly income

Potential risks of a home equity loan:

You could lose the house if you do not make payments on the loan. After you take out the loan, you'll have to make two mortgage payments, which might be difficult if you're already struggling to make ends meet.
If home values move downward in the future, you could end up owing more on the home than it's worth on the market.

What's cash-out refinancing and how does it work?

A cash-out refinance involves refinancing your home loan for more than you owe on your current mortgage. It's a way to leverage your equity in a way that doesn't involve a second payment for a HELOC or a home equity loan, and it still allows you to extract some liquid cash from the value of your home.

With a cash-out refinance, you're refinancing your home loan for whatever is still owed on the mortgage, plus an additional amount of money that will be given to you in a cash lump sum after the refinance is completed.

Requirements for a cash-out refinance:

At least 20% equity in your home
A credit score of 620 or higher
More than six months of mortgage payment history for your home
Valid proof of income
A 43% (or lower) debt-to-income ratio, meaning that your monthly debts are equal to or less than 43% of your monthly income

Potential risks of a cash-out refinance:

You'll have to refinance with current interest rates, which are higher than in previous years.
Your monthly mortgage payment could be higher after the refinance, depending on how much you've paid off already and how much you want to take out in cash.
If you can't make payments on the new mortgage loan, you could be in danger of foreclosure and losing your home.

What about term-based refinancing?

Homeowners with shorter-term loans (such as 10-year or 15-year mortgage loans) who are cash-strapped might consider refinancing to a 30-year mortgage loan. Longer loan terms have higher interest rates, but the monthly payments are lower because they're spread out over a lengthier period.

When should you think about leveraging your home equity?

Taking equity out of your house can be risky, so you'll want to make the decision practical and financially sensible.

If you're exploring how to consolidate or pay off high-interest debt (such as credit card debt), then tapping into your home equity could be a decent option for you. You can also put the money toward other investments (including additional real estate properties that might generate cash flow), or home renovations that could allow you to rent out part of your house or increase your property value.

Experts advise against using your home equity to buy a big-ticket item that depreciates quickly, like a car. "Cars decrease in value as soon as you drive them off the lot," said Haley Bartlett, a real estate agent with Your Aussie Agent. "You end up risking your home's equity for an asset that will be worth less. Be sure that whatever you are putting your home's equity in is going to give you worthwhile returns."

Alternative options

If you're still building home equity or don't want to tap into it, there are still some ways that you can use homeownership to increase your cash flow, including house hacking.

For example, Ryan Dossey, co-founder and broker at SoldFast, says that homeowners with substantial equity who are looking for ways to stretch their dollars might consider building an accessory dwelling unit or converting a garage into an apartment. "In a lot of major markets, the permitting process has become streamlined," Dossey said.

Whatever your situation, experts recommend consulting with a financial advisor before leveraging your home equity to get cash.

"A professional can provide tailored advice based on individual financial situations," said Bartlett.

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