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Fact vs. fiction: Top 8 common home equity myths — debunked

Heather Petty
Updated
Most common home equity myths (LdF via Getty Images)

Home equity is one of the greatest sources of wealth for most Americans, and the value you've built up in your home can give you access to a large sum of money, should you need it. But how you access that equity can be confusing, especially with so many options that include:

  • Home equity loans — A fixed-rate loan, sometimes called a second mortgage, that allows you to borrow against the equity of your home.

  • Home equity lines of credit (HELOC) — A variable-rate line of credit that you can draw on for up to 10 years, followed by a 20-year repayment period.

  • Cash-out refinance — Allows you to replace your current mortgage with a new mortgage and take out most of your home’s equity as cash.

  • Reverse mortgages — Type of loan for homeowners ages 62 and older to borrow against their home equity, using their home as collateral — yet instead of you repaying the lender, the lender pays you with tax-free payments.

Before you consider how best to tap your home equity — or whether it’s a good idea for your budget, financial goals and circumstances — make sure you’re not falling for the most common misconceptions about this way to borrow.

Related reading: 4 ways to get equity out of your home — and what to know before you apply

Your home equity is based on your home value, so it’s understandable where this common myth comes from. But your home equity actually is the difference between the assessed value of your home — or what your home is worth — and how much you owe on your mortgage.

Equity 🟰 [value of your home] ➖[mortgage balance]

The assessed value is different from the price you paid for your house, factoring in the condition of your home, where your home is located and how much comparable homes in your area have recently sold for, among other conditions.

Let’s say your home is assessed for $500,000. If you still owe $350,000 on your mortgage, you’d have $150,000 in home equity:

$150,000 🟰 $500,000 ➖$350,000

Unfortunately, very few lenders will finance a loan for 100% of your home equity. Most legitimate lenders allow you to access up to 80% or 85% of your home’s equity, depending on your credit score and the lender.

Any higher, and the home loan or HELOC becomes a lot riskier for both you and the lender — which means you’ll pay a higher interest rate and face stricter requirements to qualify.

Your home equity can build over time as you pay down your mortgage, but it also builds as market values rise. Recent home value increases have proven that you don’t have to live in your house a set number of years to get a home equity loan or a HELOC — you just have to qualify.

Lender requirements vary, but most requires you to meet standard requirements that include:

  • A loan-to-value ratio (LTV) below 85%

  • A debt-to-income ratio (DTI) below 43%

  • A credit score of 680 or higher

  • A solid payment history on your current debt

Your LTV ratio is key, as it determines how much equity you have and how much you can borrow. But each of these requirements work together to determine your risk, which influences the interest rate a lender will offer. If you’re considered high risk, you can expect the loan or line of credit to be more expensive.

📌 Dig deeper: Ways to build equity in your home more quickly (and why it matters)

While you can tap your equity to improve or renovate your home, the truth is there are no legal restrictions on how you use the funds you get from a home equity loan or line of credit. You can use the money to make updates or home repairs, consolidate credit card debt, pay for emergency medical expenses or even contribute to a loved one’s college tuition, which some personal loans prohibit.

But because you’re borrowing against your home, you’ll want to be more careful about how you decide to spend the money — and how you budget to pay it back.

📌 Dig deeper: Can you use a home equity loan to buy a rental or investment property?

There is some truth to this myth, but it comes down to how you use the money. Up until 2017, interest on home equity loans and HELOCs was generally tax-deductible. But with the introduction of the Tax Cuts and Jobs Act in December 2017, you can now only deduct the interest amount if you can prove to the IRS that your funds were used to “buy, build or substantially improve your home.”

If the tax cuts are extended after 2025, when many of the act’s reforms are due to expire, it’s most likely this rule on home equity interest deductions will continue after 2025 — and we’ll be sure to update this page accordingly.

Until then, if tax write-offs are a priority, speak to a tax advisor or find a trusted financial advisor to learn how to document your expenses and stay within the law when filing your return.

An in-person home appraisal used to be a standard requirement for financing, allowing for an unbiased licensed appraiser to assess the true value of your property — the collateral for your home loan. Yet just as it's changed many other aspects of life, the pandemic required mortgage lenders to adapt the way it conducted this step of the borrowing process.

Enter the no-appraisal home equity loan. Instead of sending an appraiser to your home, some lenders are using sophisticated automated valuation models, called AVMs, to determine your property's value. Yet while it can mean faster, simpler home equity loans for many borrowers, not everyone will qualify for a fully automated no-appraisal home equity loan or HELOC, especially if you don't have excellent credit. Also, AVMs review only what's in public records — and not your actual house — which can be less reliable for unique properties or rural areas where there aren't many recent home sales to compare.

Still, it's worth asking whether you're eligible for a no-appraisal home loan — and what you might be missing out on if you try it.

📌 Dig deeper: The truth about no-appraisal home equity loans: What borrowers need to know

Whether you use a home equity loan, HELOC or cash-out refinance to access your home equity is up to you. But refinancing your mortgage comes with some costs you’ll want to weigh into your decision. For example, while lenders may charge closing costs on all their home equity products, those fees are often waived for a home equity loan or HELOC as long as you keep the loan active for three years, whereas the closing costs on a cash-out refinance can be hefty — similar to what you paid on your original mortgage.

You should also consider your current mortgage interest rate compared to what the interest will be on a refinance. If you’re not getting a lower rate on your refinance, a home equity loan might be a smarter choice. While a home equity loan interest rate will often be higher than the interest rate on a mortgage refinance, the home equity loan is for a smaller amount, which means you’ll pay less interest over the life of your loan than you would for a longer mortgage.

Also called a Home Equity Conversion Mortgage (HECM), the reverse mortgage is designed to allow homeowners ages 62 or older to supplement their retirement income using the equity in their home while still living there. But reverse mortgages increased exponentially under the 2006 housing bubble and rising home values, eventually crashing during the 2008 housing and subprime mortgage crisis and leaving in its wake vulnerable seniors who’d fallen victim to unscrupulous lenders and high-pressure sales tactics.

Since then, the government has increased regulations — including the 2013 Reverse Mortgage Stabilization Act and educational work from the Consumer Financial Protection Bureau — that have helped make the reverse mortgage market a safer option for seniors. Among program changes designed to protect consumers, homeowners are required to meet with a counselor at a certified counseling agency who first makes sure you understand how the reverse mortgage works, including eligibility requirements, financial responsibilities and available alternatives. There are even government-backed reverse mortgage options through FHA-approved lenders.

📌 Dig deeper: What is a reverse mortgage? How it works, who it’s best for — and to steer clear

The ideal time for a home equity loan is when you’re going to build on or make large-scale improvements to your home, and you know the exact amount of money you’ll need for the work you’re doing. That’s because home equity loans give you a lump sum of money all at once, and if you use the funds on a substantial renovation, you can write off the loan’s interest on your taxes.

Yet there’s no restriction on how you can spend your money, with other uses including:

  • A large, unexpected expense. Car repair, medical expenses or last-minute travel costs can take anyone by surprise, and if you don’t have an emergency fund, a home equity loan could help.

  • Debt consolidation. Your home equity can help you consolidate and pay off high-interest debt without a personal loan. If you can get a lower interest rate than you’re paying on your separate debts — and you’re committed to cutting up your credit cards — you stand to save a lot in interest.

  • College expenses. While you may be able to get a lower rate with a student loan, private student loan interest rates range from 4% to 16%. The average 8.41% with a home equity loan could be worth considering.

  • Investing in real estate. If you’re interested in investing in an income property, using your home equity to put down a higher down payment might help you land a lower interest rate on the new mortgage. Between the business write-offs and deducting your home equity loan interest, it could save you money in the long run. Speak to a tax advisor or trusted financial advisor about how to document your expenses and stay within the law.

📌 Dig deeper: Top renovations that can increase your home's value — and quality of life as you age

Home equity loans and HELOCs allow you to borrow against your home equity, but they differ in a few key ways when it comes to interest rates, how you’ll receive your funds and repayment terms.

Home equity loan

HELOC

Interest rate

Fixed interest rate

Variable interest rate

Funds

Lump sum

Only draw what you need

Terms

5 to 30 years

10-year draw period and 20-year repayment period

Repayment

Consistent monthly payment

Interest-only payments for the draw period, followed by variable payments that depend on changing rates

Fees

Appraisal and closing costs often waived as long as the loan is active for 3+ years

Annual fee common, with closing costs typically waived as long as the loan is active for 3+ years

 

Some lenders are starting to offer a fixed-rate option on their HELOCs. The rules around these options vary, but you typically take advantage of lower interest rates during your draw period and then turn a portion of what you’ve borrowed from your HELOC into a fixed-rate loan for repayments. Be aware that repayments on this new loan start immediately — and your rate stays as is for that sum of money, even if rates drop further.

Not sure a home equity loan is for you? Learn more about how they work with these common questions.

Some lenders offer interest rate reductions of 0.25% to 0.50% if you sign up for autopay — or automatic payments from a bank account. Call your bank or credit union directly to ask about autopay or any other discounts you might be eligible for.

New garage doors, entry doors and manufactured stone veneer tend to have the highest ROI — or return on investment — of all home improvement projects. Yet you’ll also want to balance resale value with comfort, safety and the ability to age in place. Learn more about home improvements in our guide to the top home renovations offering bang for your buck and peace of mind as you age.

While timelines vary by lender, you can expect a wait time of around two to six weeks or longer after you’ve submitted your paperwork. Online lenders tend to have the fastest processing times.

Just because you've already owned a home doesn't mean you'll be denied assistance. Many homebuyer assistance programs are for first-time buyers, but they tend to use a liberal definition of "first time." And there are a surprising number of options for senior buyers and retirees, for people who've purchased a home before or even people who need help paying off their current home. Learn more about how these programs work and you might qualify in our comprehensive guide to homebuyer assistance programs.

Like other types of debt, loans are typically paid out of your estate when you die. However, depending on where you live and your state's laws around debt and inheritance, your spouse may be partially responsible for paying off your loan debt. Learn more about how to protect your loved ones in our guide to loans after a death.

Heather Petty is a finance writer who specializes in consumer and business banking, personal and home lending, debt management and saving money. After falling victim to a disreputable mortgage broker when buying her first home, Heather set on a mission to help people avoid similar experiences when managing their own finances. Her expertise and analysis has been featured on MSN, Nasdaq, Credit.com and Finder, among other financial publications. When she's not breaking down the complexities of finance, she's a young adult mystery writer of an internationally acclaimed series — and counting.

Article edited by Kelly Suzan Waggoner

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