Table of Contents
- What Is Home Equity?
- How Home Equity Works
- How to Calculate Your Home Equity
- Example of Home Equity
- Important Note on Home Equity
- How to Borrow Against Home Equity
- Home Equity Loan
- Home Equity Line of Credit
- Fixed-Rate Home Equity Line of Credit
- Cash-Out Refinance
- Warning on Discrimination
- How to Use Home Equity
- How to Increase Your Home Equity
- Pros and Cons of Borrowing on Home Equity
- What Is a Home Equity Loan?
- How Can I Get a Home Equity Loan?
- What Is a Home Equity Line of Credit?
- How Much Equity Do I Have in My Home?
- The Bottom Line
What Is Home Equity?
Let me explain home equity directly: it's the difference between what you owe on your mortgage and what your home is worth. Essentially, it's the part of the home you own outright. Your equity can grow as you make payments and as the property's value rises over time.
More technically, home equity is your property's current market value minus any liens attached to it, like a mortgage. It's an asset you can borrow against for key financial needs, such as paying off high-interest debt or covering college tuition. I'll cover how it works, how to calculate it, and ways to use it.
Key Takeaways
- Home equity is the current market value of your home minus any liens like a mortgage.
- You can leverage it by backing a home equity loan or line of credit.
- A down payment of 20% or more gives you immediate equity.
- Equity can increase or decrease based on your home's market value.
How Home Equity Works
If your home is financed partly or fully with a mortgage, the lender has an interest in it until you pay off the loan. Home equity is the portion of the home's current value that you own free and clear.
You get immediate equity with a down payment. From there, it grows as you make mortgage payments, where part goes to interest and part reduces the principal you owe.
Equity can also grow if your property's value appreciates. But if the value drops, you lose equity. Taking out a second mortgage using your equity as collateral can reduce it too.
How to Calculate Your Home Equity
Equity is simply the difference between your home's worth and what's owed on the mortgage. Start by estimating your home's value—look at recent sales of similar homes in your area. Say that's $350,000, and your loan balance is $150,000. Then, equity equals home value minus loan balance, so $350,000 minus $150,000 gives you $200,000 in equity.
Example of Home Equity
Suppose you buy a home for $300,000 with a 20% down payment, covering $60,000 and mortgaging the rest at $240,000. You start with $60,000 in equity.
If the value stays the same over two years and $15,000 of payments go to principal, your equity becomes $75,000.
If the home's value rises by $100,000 in those two years, your equity would then be $175,000.
Important Note on Home Equity
Home equity counts as an asset in your net worth, but it's not liquid—you can't quickly turn it into cash. Its value depends on a market appraisal, which doesn't guarantee a sale at that price.
How to Borrow Against Home Equity
Interest rates on equity-based borrowing are usually lower than credit cards or personal loans since it's secured by your home. The interest is often tax-deductible if used for home improvements. You can access funds through home equity loans, HELOCs, or cash-out refinances.
Home Equity Loan
This is like a second mortgage: you borrow a lump sum against your equity at a fixed rate over a set period. It's often used for big expenses like repairs or tuition.
Home Equity Line of Credit
A HELOC is a revolving credit line with adjustable rates, letting you borrow up to a limit over time, similar to a credit card. You pay it off and can borrow again.
Fixed-Rate Home Equity Line of Credit
You can convert part of a HELOC to a fixed rate, paying it off over a specific time. Check lender rules, as they vary on usage.
Cash-Out Refinance
This involves getting a new, larger mortgage using your equity, paying off the old one, and keeping the difference for any use. The funds are tax-free as debt, not income.
Warning on Discrimination
Mortgage discrimination is illegal. If you suspect it based on race, religion, sex, or other protected factors, report to the CFPB or HUD.
How to Use Home Equity
Use your equity wisely. Eliminate PMI once equity hits 20%—it's automatic at 22%, but you can request at 20%. Consolidate high-interest debt with equity borrowing, as rates are lower. Fund major expenses like tuition or weddings to avoid costlier options.
How to Increase Your Home Equity
To build equity, make a large down payment for instant gains. Pick a mortgage that pays down principal steadily, avoiding interest-only types. Pay more than the minimum each month. Stay in your home long-term to benefit from value increases. Make value-adding improvements after researching what works.
Pros and Cons of Borrowing on Home Equity
Borrowing has upsides like less stringent approval since equity secures the loan, lower interest rates than unsecured options, and tax-deductible interest for home improvements.
Pros Explained
- Less stringent requirements: Lenders rely on your equity to reduce risk, making approval easier.
- Lower interest rates: Saves money compared to credit cards.
- Tax deductible interest: For capital improvements, this cuts costs.
Cons Explained
- Added debt: Increases monthly payments and can hurt your credit score.
- Potential fees: These add to the total cost.
- Restricted use: Sometimes funds must go toward specific purposes like renovations.
What Is a Home Equity Loan?
It's borrowing against your home's appraised value, received as a lump sum with monthly payments like a second mortgage.
How Can I Get a Home Equity Loan?
Contact a lender offering these. Get a professional appraisal, then they'll check your credit and debt-to-income ratio. If approved, you get a lump sum after closing, with fixed payments.
What Is a Home Equity Line of Credit?
A HELOC is a revolving line based on equity, usable as needed with a draw period (often 10 years) for interest-only payments, followed by full repayment.
How Much Equity Do I Have in My Home?
You build it by paying down principal, starting with any down payment. Calculate by dividing your mortgage balance by the home's appraised value.
The Bottom Line
Home equity is the value you control versus the lender's share, built from down payments, principal reductions, and appreciation. It creates an asset and borrowing power.
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