What is equity in a home?
Find out how to calculate and increase home equity, as well as whether to borrow against your home’s value.
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Amy Fontinelle is a personal finance journalist and expert on budgeting, credit cards, mortgages, insurance, and taxes. She has bylines at Forbes, The Motley Fool, Reader's Digest, and USA Today.
Updated August 23, 2024, 1:46 PM EDT
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With each mortgage payment or housing market uptick, your home equity grows. Homeowners who used a cash-out refinance in the first three months of 2024 took out an average of $100,000 in equity, according to ICE Mortgage Technology. Many people never touch their equity; others view equity as a tool for accomplishing their financial goals.
If you’re trying to decide whether to tap into your home’s equity, here is what you need to know about what it is, how you can access it, and how borrowing against your equity could help or hurt you.
What is home equity?
Home equity is the difference between how much your home is worth and how much you owe. It’s the part of your home’s value that’s truly yours.
If your home’s value is $400,000 and your mortgage balance is $360,000, your equity is $40,000, or 10%. Another way to look at it is the loan-to-value ratio (LTV), which is how much you owe compared to the home’s value — in this case, $360,000 to $400,000, or 90% LTV.
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How to calculate home equity
Lenders calculate home equity by using an appraisal and comparing that value to your loan balance. If you want to get an idea of your home’s value but don’t want to pay for an appraisal, you can use a free estimate tool from a real estate website, such as Realtor.com.
Once you know your home’s value, take a look at your most recent mortgage statement and find your principal balance. That’s how much you still owe. Subtract that amount from your home’s value to get your equity in dollars.
To find out what percentage of equity you have, divide the dollar amount of your equity by your home’s value. It’s possible to have negative equity if you owe more than your home is worth:
How can you increase your home equity?
There are several strategies you can try to increase your home equity:
- Pay down your mortgage principal: If your home’s value holds steady or goes up, paying down your loan will increase your equity. However, if you’re looking to increase equity so that you can take out a larger home equity loan, paying down mortgage principal would be counterproductive. It would mean putting more money into your home when your goal is to take money out.
- Improve your home: Making upgrades to your home can raise its value — which also means more equity, if you’re not borrowing from your home to make those changes. Keep in mind that unless your home is inferior to otherwise comparable homes in your area, the upgrades you make might not dramatically boost your equity.
- Make biweekly payments: If you follow your amortization schedule, you’ll be making 12 payments a year. But, if you make biweekly payments, you can pay down your balance faster by making 13 payments in a year. To use this method, divide your monthly mortgage payment in half and pay that amount every two weeks. For example, if your monthly payment is $2,000, you’d pay $24,000 in a year if you made one payment a month. But if you make a $1,000 payment every two weeks, you’ll end up paying $26,000 toward your mortgage — adding an extra payment. This helps bring down your mortgage balance faster and boost your equity.
- Wait for value to increase: Demand for homes tends to push property values higher. If you live in a desirable neighborhood, other nearby homes might sell for more money and boost the market value of your home, too. As long as you maintain your home and keep up with repairs, the value of your property should continue to rise.
To sum up:
Since home equity is the value of your home minus the amount you owe, you can expect your equity to go up if your property value rises or the loan amount shrinks. It might not make sense to pay extra toward the loan only to borrow against equity later.
Home equity: Pros and cons
There are benefits to accessing your equity, but there are also consequences. Here’s what to consider before you borrow against your home equity:
Pros
- Low interest rate: Since a home equity loan is secured by your home, it usually has a lower interest rate than personal loans or credit cards. Combined with a long repayment period, the monthly payments can be very affordable.
- Flexibility: Some types of loans, like student loans and auto loans, can only be used for one thing. Home equity loans can be used for whatever you want, whether that’s consolidating debt, replacing your roof, or starting a business.
- Low closing costs: When you access your equity through a home equity loan or line of credit, the lender may waive your closing costs.
- Large loan amounts: If you have lots of home equity, borrowing against it could be the best way to access lots of cash.
Cons
- High total interest cost: When you borrow against your equity, you may have up to 30 years to repay it. For example, financing $100,000 at 10% for 30 years would cost $215,926.
- Repayment risk: If you can’t repay your home equity loan, you could lose your home to foreclosure. An unsecured personal loan could be a better choice if you don’t want that risk.
- Loss of flexibility: If you owe more on your home relative to its value, it could be harder to sell your home and move if the housing market goes down.
- Spending temptation: Having access to a large lump sum or line of credit can make you feel wealthier than you are. You might spend more on things that don’t improve your life in a meaningful way.
How to access home equity
You have several choices to use your home’s equity, depending on how much you need and whether you need a lump sum at once or funds over time. While you can contact your original mortgage lender to tap into your home’s equity, you should still shop around with a few other lenders to make sure you’re getting the best offer.
Here are three ways ways to borrow against your equity:
- Home equity loan: A home equity loan lets you borrow a lump sum against your equity. The loan has a fixed interest rate and equal monthly payments. The term can be anywhere from five to 30 years, depending on the lender and what you qualify for.
- Home equity line of credit (HELOC): A HELOC gives you the option to borrow against your equity in a series of draws over time; for example, you might have a 10-year draw period followed by a 20-year repayment period. You can borrow up to your credit limit, or borrow nothing at all, just having the line available in case you need it. The interest rate is variable, but you may have the option to lock in a fixed rate on some or all of the money you borrow. Your monthly payment can vary with changes in the interest rate and the amount you’ve borrowed, and you might be able to make interest-only payments during the first few years.
- Cash-out refinance: A cash-out refinance replaces your existing mortgage with a new, larger mortgage; you’ll receive the difference as a lump sum. If current interest rates are lower than your existing mortgage rate, a cash-out refinance could be a good way to access your home equity while improving your loan terms.
Tip:
Consider what you’ll use the funds for. A home equity loan gives you a lump sum, which is good if you know how much money you need upfront. A HELOC, on the other hand, lets you draw funds over time if you need more flexibility.
What is equity in a home FAQ
What is the difference between home equity and home value?
Home value is how much your home is worth, or how much someone might pay for it if you decided to sell. Home equity is how much of your home’s value belongs to you, not your lender. If you don’t have a mortgage, your home equity and home value are the same.
Can you use home equity to buy another home?
Yes. You can use your home equity however you want. Real estate investors sometimes use their equity to buy another home without even cashing out through a cross-collateralization loan.
How does home equity affect your net worth?
Your home equity is an asset that increases your net worth. If your IRA has $40,000, your savings has $30,000, your checking has $20,000, and your home is worth $400,000, your total assets are worth $490,000. If you owe $300,000 on your mortgage, then your net worth is $190,000.
Your net worth in this example includes $100,000 in home equity and $90,000 in other assets. Without the home equity, your net worth would only be $90,000.
It’s also possible to have negative home equity, which would lower your net worth.
What are the risks of borrowing against home equity?
Borrowing against home equity gives you an additional financial obligation each month: Increasing your expenses can put you in a tighter spot if your income goes down or if other expenses you can’t control go up.
If you don’t make payments on your home equity loan, you could go into default, which would hurt your credit score. Your loan servicer could foreclose, which means you could lose your home. Also, if home values decline, you might not get enough to repay what you owe if you need to sell your home.