What is home equity?
Home equity is the portion of your home’s value that’s not ‘secured by any liens.’ In other words, it’s the portion you own free and clear because it’s not owed to a mortgage lender.
For example, if your home is worth $250,000 and you owe $100,000 on your mortgage, you have $150,000 of equity.
Home equity is a valuable asset by itself. But equity can also be tapped to help grow your wealth, if you know how to use it correctly. Here’s how it works.
In this article (Skip to...)
- How to calculate home equity
- What’s the purpose of home equity?
- How do I access my equity?
- How much can I borrow?
- Should you borrow from your equity?
- What is negative equity?
- Home equity FAQ
How to calculate home equity
You need to know only two things to calculate your own equity:
- Your home’s current market value
- Your total outstanding mortgage balance (primary mortgage plus second mortgage, if you have one)
From here, the equation is simple:
Home Value – Total Mortgage Balance = Your Home Equity
Here’s a very basic example of the home equity calculation in practice:
- Home value: $200,000
- Mortgage loan balance: $100,000
- Home equity: $100,000 ($200,000 - $100,000)
Normally, homeowners build equity in two ways.
First, the mortgage balance falls a little each month as you pay down your debt. The lower your mortgage loan amount, the greater your equity.
Second, rising home prices typically push up the market value of the property. As your home’s value rises, it automatically increases your equity.
Finding your mortgage balance and home value
Finding the outstanding balance on your home loan is easy. You can probably log onto your mortgage account for an exact and up-to-date figure. Or you can check your most recent paper statement.
Determining your home’s current market value might be a little more difficult.
In most cases, this is not equal to the purchase price you paid when you bought the home, because real estate tends to increase in value over time.
You can get a rough idea of your home’s current value using online estimator services, such as Realtor.com, RE/MAX, and Zillow. Or perhaps you already know the prices that similar homes to yours have sold for in your neighborhood.
You might even be able to call a friendly local real estate agent for help if you have a friend or acquaintance in the business.
What’s the purpose of home equity?
Home equity is a valuable asset and a key benefit of homeownership. It’s one of the main ways individuals and families build wealth and financial security.
Keep in mind, equity is not liquid wealth. You typically have to take out a loan to access it (more details on that below).
But if you have enough equity, there are ways you can actively use it to your advantage.
Some of the biggest ways homeowners benefit from their equity include:
- The ability to borrow large sums of money from your equity at a very low interest rate, perhaps for emergencies or large expenses like home renovations
- Using equity as leverage to lower your mortgage costs. Homeowners who build up enough equity can get rid of private mortgage insurance (PMI) and sometimes refinance into a lower interest rate
- Increasing your profits when you sell the home. The more equity you have, the more money you’ll make when you eventually sell. This can be a key asset for homeowners moving to a new home or downsizing in retirement
Borrowing large sums from your equity
One of the key benefits of building home equity is that you’re creating a pool of wealth from which you can borrow.
When you borrow money from your equity, the loan is secured by your home (just like your original mortgage). That means home equity borrowing has far lower interest rates than other sources of money, like credit cards or personal loans.
For homeowners with enough equity built up, this is often the cheapest way to finance big expenses like:
- Home renovations, remodeling, or repairs
- Buying a second home or investment property
- Large, unexpected medical expenses
- Paying college tuition for yourself or a child
- Consolidating high-interest debts that are costing you a lot in interest
- Starting up a small business
- Creating an emergency fund
Of course, home equity borrowing isn’t a free ride. You’re still borrowing from a mortgage lender, even though it feels like you’re borrowing from yourself. That means you’ll pay interest on the loan. And ultimately, you’re increasing your debt and reducing your net worth.
So it’s best to do this only when necessary; for instance, if you have a huge and unexpected medical bill, or you’re starting a new, surefire company or you’ve built up a pile of expensive debts and need to consolidate them.
By the way, federal regulator the Consumer Financial Protection Bureau warns against “borrowing against your home as part of an investment strategy.”
Canceling mortgage insurance
Many homeowners find private mortgage insurance (PMI) a real burden.
Paying PMI on a conventional loan — or mortgage insurance premiums (MIP) on an FHA loan — can easily add hundreds of dollars to your monthly mortgage payment.
The good news for homeowners with conventional loans is that they can stop paying PMI once their equity hits 20%. You simply call your mortgage loan servicer and ask to have it removed.
But that rule doesn’t apply to FHA loans.
What FHA homeowners can do once they have 20% equity is refinance to a conventional loan without PMI.
Their 20% equity counts as a 20% down payment, putting them over the threshold where mortgage insurance is no longer required.
Getting a lower mortgage rate when refinancing
When lenders look at any mortgage application, they focus on three main things:
- Your credit score
- Your debt-to-income ratio (DTI)
- Your loan-to-value ratio (LTV)
Lenders will adjust the mortgage rate you’re quoted to reflect how you measure up against those criteria.
The more home equity you have when you refinance, the lower your loan-to-value ratio. This is a good thing in lenders’ eyes because it decreases your risk as a borrower, and you’ll likely be offered a lower mortgage rate.
And, of course, if you managed to boost your credit score and pay down some of your debts in the meantime, that rate could be ultra-low.
Increased profits when you sell your home
Home equity can also act as a nest egg for your future life, helping you save money for when you move or retire.
When you sell your home, part of the proceeds are used to pay off your remaining mortgage balance. The less you owe on your mortgage, and the more equity you have when you sell, the more money you’ll get to keep from the sale.
These funds can be used to make a down payment on your next home, or in some cases even buy the property outright with cash.
For retirees downsizing to a smaller home or retirement community with lower housing costs, cashing-out home equity when they sell can also provide lump sum for living expenses.
How do I access my equity?
Home equity is not liquid wealth. Although it’s one of your assets, the money is tied up in your house. You can’t ‘spend’ your home’s value, per se.
To access your home’s equity and turn it into liquid cash, you either need to sell the home or take out a loan secured by its value.
Of course, you wouldn’t sell your home to access equity unless you were planning to move anyway. So most homeowners who want to cash-out their home equity while living in the house use one of these three methods:
- Cash-out refinance — You get a new mortgage with a larger loan amount to replace your existing mortgage, and you walk away with a check for the difference. Typically these have the highest closing costs but the lowest mortgage rates
- Home equity loan (HEL) — You borrow a lump sum as a second mortgage. You pay it back, usually at a fixed interest rate, over a set period of time. This is a second monthly payment on top of your primary mortgage payments
- Home equity line of credit (HELOC) — This is a bit like a credit card. You get a credit limit you can borrow against, pay back, and reborrow as often as you want within a certain time frame (the ‘draw period’). HELOCs typically have variable interest rates that are much, much lower than credit cards. But these loans are complicated so make sure you fully understand them before you commit
There are other ways in which you can tap your equity, too.
For example, you can borrow for home improvements using an FHA 203k home purchase loan or refinance. Or, if you are 62 years or older, you can explore reverse mortgages, which provide cash but roll up interest and loan costs so you pay nothing until you move or pass away.
It’s important to recognize that all of these loans — including HELs and HELOCs, which are ‘second mortgages’ — are secured loans. You’re using your home as collateral. So, if you fall too far behind on payments for any of them, you could face foreclosure.
Home equity loan, HELOC, or cash-out refinance: Which is right for you?
Choosing between a cash-out refinance, home equity loan, or home equity line of credit is something you want to get right. So be sure to read about them each in-depth. See:
- What are the benefits of a cash-out refinance?
- HELOC vs. home equity loan: Which is right for you?
- Cash-out refinance vs home equity loan
We don’t have space here to tell you all you need to know. But here are some of the most important characteristics of these loans:
- Cash-out refinances tend to have lower rates than HELs or HELOCs, but higher closing costs
- Home equity lines of credit (HELOCs) often have the lowest upfront fees of the three, and are the most flexible. But they’re also complex and have downsides that sometimes trip up unwary borrowers
- Home equity loans and HELOCs typically have a shorter repayment period than cash-out refinances, and you’ll have a smaller loan amount meaning you pay less interest
- You’ll likely pay less interest when you use any of these products to borrow a large amount than you would using a loan that is not secured by your home, such as a personal loan
- But personal loans have lower (or often zero) closing costs. So they may be better when you want to borrow smaller sums
- You need to shop around for the best deal with all these products. Offers vary widely and you could save thousands by seeking out the right lender for you
- Pay attention to the annual percentage rates (APRs) you’re quoted. These reflect the loan’s costs as well as its interest rate. So they’re often a better guide to value for money
There’s nothing especially scary about tapping your home equity. But it’s a serious business, so do your homework and be sure you’re making the right decision for your personal finances.
How much can you borrow from your home equity?
Don’t imagine you can withdraw all the equity you have in your home.
You may be able to find a lender that’s a little more flexible, but most want you to retain 20% of your property value as equity. That means you can usually borrow only 80% of the value of your home, including the amount you already owe on your existing mortgage.
Let’s look at the example we used earlier:
- Home value: $200,000
- You can borrow up to 80% of that: $160,000 ($200,000 x 80% = $160,000)
- Existing mortgage balance: $100,000
- Maximum amount of equity you can borrow: $60,000 ($160,000 - $100,000)
The maximum amount you can borrow compared to your home’s value is typically expressed as a maximum ‘loan-to-value ratio,’ or ‘LTV.’
In these terms, the maximum LTV on most cash-out refinance loans is 80%.
Lenders have this rule to lower the risk of borrowers defaulting. But it also adds to your wider financial health.
Should you use your home equity to borrow?
It’s up to you to decide what you borrow and spend from your home equity. But most financial advisers would warn against borrowing to extend an unsustainable lifestyle or to indulge personal whims.
For instance, using home equity to fund a vacation, wedding, or another one-time expense with no return on investment is generally regarded as a bad move.
It’s one thing to put your home on the line for a rare emergency that threatens your financial security, and quite another to do so for luxury purchases.
On the flip side, using your home equity to put your life back on track by consolidating expensive, out-of-control debts is often a very smart move — providing you’ve first consulted a certified financial counselor.
Many people also use home equity for renovations that increase the value of the home. This can benefit you in the long run by netting you a bigger profit when you eventually sell.
The main consideration to keep in mind when borrowing from home equity is that your house is used as collateral.
So if you can’t repay the loan — for instance, if you were to run up debts again and couldn’t afford monthly mortgage payments — you could face foreclosure.
This underscores the importance of tapping home equity only when necessary and using the money for purposes that improve your overall financial situation.
What is negative equity?
Most homeowners will see their equity increase over time and they pay down their mortgages and home prices increase.
Sometimes, though, home prices fall, either nationwide or in a local property market. If home prices drop sharply enough, a homeowner can end up owing more on their mortgage than the home is worth.
When that happens, a loan is said to be in “negative equity” or to be “underwater.”
For example, say you bought a home for $350,000 and your current mortgage balance is $300,000. If that home’s value falls to $275,000, you now owe $25,000 more than the home is worth.
Those can be difficult times for homeowners. But, luckily, they’re relatively rare and usually brief. Here’s a graph showing home price trends since 1960:
Source: FRED, Federal Reserve Bank of St. Louis
If you find yourself in negative equity, there are a number of relief programs that can help you refinance into a more affordable mortgage and get your finances back on track.
You can read more about mortgage relief refinance programs here.
Home equity FAQ
What does it mean to have equity in your home?
Your home equity is the portion of your home’s value that you don’t owe to a mortgage lender. You’ll build equity as you pay down your mortgage and as your home’s value increases. If you have enough equity, you may be able to borrow from it at a low interest rate.
What happens when you pull equity out of your house?
When you withdraw equity from your house, you increase the amount of debt that’s secured by your home. You may face higher monthly mortgage payments or an additional monthly payment on a ‘second mortgage.’ But you’ll get a lump sum or a line of credit you can spend in any way you want.
What is a good amount of equity to have in your home?
The more home equity you have, the better. Equity increases your overall net worth and lets you use your home as a financial safety net. Having 20% equity is a key benchmark because it often lets you cancel private mortgage insurance (PMI) or refinance into a lower interest rate. You typically need significantly more than 20% if you want to cash-out home equity.
How do you lose equity in your home?
There are three main ways to ‘lose’ equity: 1) You borrow more against the home (e.g. using a cash-out refinance or second mortgage); 2) You fall behind with mortgage payments; 3) Your home’s value decreases.
Do you have equity if your home is paid off?
You bet! You have 100% equity. If you sell, you’ll get to keep all the proceeds (minus closing costs). You can also borrow against this equity, but that creates a new ‘lien’ which means your home could still be foreclosed if you don’t repay the loan.
How much equity can I cash out?
Most lenders want you to retain 20% of your home’s value as equity. So you can usually take out 80% of your home’s current market value. But that’s the maximum for all your secured borrowing, so it includes your existing mortgage(s).
How much equity should I have in my home before selling?
There’s no rule for this. Some homeowners sell with little or no equity. But, if you have enough equity to make a 20% down payment on your new home, you should be able to avoid mortgage insurance.
How do I know if I have 20% equity in my home?
Most people can get a good idea of their home’s value with some online research and maybe a call to a real estate agent friend. Deduct your current mortgage balance from that value, and that’s your equity. You might also be able to get an estimate by contacting your mortgage loan servicer (the company you make payments to).
What’s the best way to cash-out home equity?
That depends on your needs. For some, it’s a cash-out refinance. For others, it’s a home equity loan or HELOC. Make sure you pick the right one by reading the information above and clicking the links to access more details.
Do you qualify to cash out your equity?
Home equity can be a great way to finance home improvements, debt consolidation, and other large expenses. And today’s low rates make home equity borrowing more affordable.
But you need to be eligible to take out a new loan against your home’s value. Typically, you need significantly more than 20% equity and good credit to cash-out.
A mortgage lender can tell you whether you qualify to cash out home equity, and how much you can borrow. You can check your eligibility right here.
To calculate your home equity, subtract the amount of the outstanding mortgage loan from the price paid for the property. At the time you buy, your home equity would be $17,500 or the amount of your down payment. For perspective, once you have paid off your mortgage you'll have 100% equity in the home.How do you understand home equity and how do you use it? ›
To calculate your home equity, subtract the amount of the outstanding mortgage loan from the price paid for the property. At the time you buy, your home equity would be $17,500 or the amount of your down payment. For perspective, once you have paid off your mortgage you'll have 100% equity in the home.How do you work out how much equity I can use? ›
A lender calculates usable equity as 80% of the value of the property minus the loan balance. For example, say your home is valued at $800,000 and you have a home loan of $440,000. Your lender will calculate 80% of the value of the property – 80% of $800,000 is $640,000.How do I use my home equity to my benefit? ›
There are three main ways you can borrow against your home's equity: a home equity loan, a home equity line of credit or a cash-out refinance. Using equity is a smart way to borrow money because home equity money comes with lower interest rates.Can you explain to me how an home equity loan works? ›
A home equity loan is a second mortgage, meaning a debt secured by your property in addition to the first mortgage you used to buy it. When you get a home equity loan, your lender will pay out a single lump sum. Once you've received your loan, you start repaying it right away at a fixed interest rate.What is the easiest way to explain equity? ›
The term “equity” refers to fairness and justice and is distinguished from equality: Whereas equality means providing the same to all, equity means recognizing that we do not all start from the same place and must acknowledge and make adjustments to imbalances.What is a simple way to understand equity? ›
Equity represents the value that would be returned to a company's shareholders if all of the assets were liquidated and all of the company's debts were paid off. We can also think of equity as a degree of residual ownership in a firm or asset after subtracting all debts associated with that asset.How much cash can I pull from my home equity? ›
Although the amount of equity you can take out of your home varies from lender to lender, most allow you to borrow 80 percent to 85 percent of your home's appraised value.How much cash can I get from my equity? ›
Borrowers can usually access up to 85% of their home's value. You'd receive the funds from a home equity loan in one lump sum and can use the money for any reason.Can you cash out 100% equity? ›
Remember that your lender won't let you cash out 100% of the equity you have unless you qualify for a VA refinance. Take a careful look at your current equity before you commit. Make sure that you can convert enough equity to accomplish your goals.
Can I use the equity in my home to pay off debt? In short, yes — if you meet a lender's requirements. You may be able to use your home equity to finance many financial goals, including paying for home improvements, consolidating high-interest credit card debt or paying off student loans.Is it wise to use your home equity? ›
A home equity loan could be a good idea if you use the funds to make home improvements or consolidate debt with a lower interest rate. However, a home equity loan is a bad idea if it will overburden your finances or only serves to shift debt around.What are the disadvantages of a home equity loan? ›
Home Equity Loan Disadvantages
Higher Interest Rate Than a HELOC: Home equity loans tend to have a higher interest rate than home equity lines of credit, so you may pay more interest over the life of the loan. Your Home Will Be Used As Collateral: Failure to make on-time monthly payments will hurt your credit score.
Home equity loans and HELOCs are two of the most common ways homeowners tap into their equity without refinancing. Both allow you to borrow against your home equity, just in slightly different ways. With a home equity loan, you get a lump-sum payment and then repay the loan monthly over time.Do you pay yourself back with a home equity loan? ›
However, remember that the money you take from your home's equity is a loan. You must pay it back and will pay interest on the amount you borrow. Before borrowing the money from your equity, make sure you can afford the payments, and that paying interest makes sense for the reason you're borrowing the funds.What is the cheapest way to get equity out of your house? ›
HELOCs are generally the cheapest type of loan because you pay interest only on what you actually borrow. There are also no closing costs. You just have to be sure that you can repay the entire balance by the time that the repayment period expires.Is equity better than money? ›
Cash has a guaranteed value (setting aside changes like inflation), while equity can end up being worth a lot more or less than anyone's best guess. Cash is a commodity; equity in a company is not. A candidate's response to equity vs. cash may stem from their risk preference.What is an example of equity for dummies? ›
The total equity is the value minus all liabilities. This definition may apply to personal or corporate ownership. For instance, if you own a car, its value is the current resale value minus the amount of any outstanding car loan. So a car worth $10,000 with an outstanding $3,000 loan has $7,000 in equity.How does equity make you money? ›
Equity financing is the process of raising capital through the sale of shares. Companies raise money because they might have a short-term need to pay bills or need funds for a long-term project that promotes growth. By selling shares, a business effectively sells ownership in its company in return for cash.What are some examples of equity? ›
For example, if someone owns a house worth $400,000 and owes $300,000 on the mortgage, that means the owner has $100,000 in equity. For example, if a company's total book value of assets amount to $1,000,000 and total liabilities are $300,000 the shareholders' equity would be $700,000.
Equity in a home is the difference between what your home is currently worth and what you owe on your mortgage. For instance, if you owe $200,000 on your mortgage and your property is worth $250,000, then you have $50,000 of equity in your property.Is cashing out home equity a good idea? ›
With a cash-out refinance, you'll get a new mortgage for more than you currently owe, allowing you to keep the difference as cash. A cash-out refinance can be a good idea if you have a good reason to tap the value in your home, like paying for college or home renovations.What is an example of home equity? ›
For example, let's say you bought a $250,000 home with a $200,000 mortgage. A few years later, your home appraises for $300,000 because the housing market is hot. If you'd paid the loan down to $150,000, you'd have $150,000 in home equity.What is the most equity you can take out of your house? ›
You'll normally get between 20% and 60% of the market value of your home (or of the part you sell). When considering a home reversion plan, you should check: Whether or not you can release equity in several payments or in one lump sum.Do you have to pay back an equity cash out? ›
The money you receive after finalizing the refinance with cash out can be used for almost anything, including buying a vacation home, paying for college tuition or medical bills. But beware that the money you get with a cash-out refinance is not free cash. It's a loan that must be paid back with interest.What happens when you cash out your equity? ›
Cash-out refinancing replaces your current home mortgage with another, bigger mortgage, allowing you to access the difference between the two loans (your current one and the new one) in cash. The cash amount is based on the value of the equity you've built up in your home.How soon can you take out equity? ›
How Soon Can You Get A HELOC After Purchasing A Home? A HELOC can be obtained 30-45 days after the purchase of a home. However, borrowers will need to meet all of the necessary lender requirements, including 15-20% equity in home, good repayment history, and more.What credit score is needed for a home equity loan? ›
A credit score of 680 or higher will most likely qualify you for a loan as long as you also meet equity requirements, but a credit score of at least 700 is preferred by most lenders. In some cases, homeowners with credit scores of 620 to 679 may also be approved.How much is a 50000 home equity loan payment? ›
Loan payment example: on a $50,000 loan for 120 months at 7.50% interest rate, monthly payments would be $593.51. Payment example does not include amounts for taxes and insurance premiums.Why cash out equity? ›
If your home value has climbed or you've built up equity over time by making payments, a cash-out refinance might make sense for you. Cash-out refinancing is a very low-interest way to borrow the money you need for home improvements, tuition, debt consolidation or other expenses.
The truth is that home equity loan approval can take anywhere from a week—or two up to months in some cases. Most lenders will tell you that the average window of time it takes to get a home equity loan is between two and six weeks, with most closings happening within a month.Do you have to use the same bank for a home equity loan? ›
While it's definitely possible to get a home equity loan using the same bank that originated your mortgage, it's not necessary by any means.How much home equity is a good amount? ›
Depending on your financial history, lenders generally want to see an LTV of 80% or less, which means you have at least 20% equity in your home. In most cases, you can borrow up to 80% of your home's value in total. An example: Let's say your home is worth $200,000 and you still owe $100,000.Is equity really worth it? ›
Offering equity compensation to employees can help a company reserve their funding for operations, starting initiatives and investing, and it can help reduce spending money on high salaries. This is especially common for startup companies that may be reliant on seed funding, and may not have a large cash flow.Can you lose your home to an equity loan? ›
Home equity loans use your home as collateral. If you can't keep up with payments, you could lose your home. Home equity loans should only be used to add to your home's value. If you've tapped too much equity and your home's value plummets, you could go underwater and be unable to move or sell your home.Why equity is better than loan? ›
With equity financing, there is no loan to repay. The business doesn't have to make a monthly loan payment which can be particularly important if the business doesn't initially generate a profit. This in turn, gives you the freedom to channel more money into your growing business. Credit issues gone.Is equity better than loan? ›
Equity financing may be less risky than debt financing because you don't have a loan to repay or collateral at stake. Debt also requires regular repayments, which can hurt your company's cash flow and its ability to grow.Can you sell equity in your house? ›
If you can no longer afford to stay in your home, but you've built up equity in your home, one option is to sell it and use the proceeds to help pay off your mortgage and any missed payments. This is called selling with equity, or an equity sale.How long is a home equity loan good for? ›
How long do you have to repay a home equity loan? You'll make fixed monthly payments until the loan is paid off. Most terms range from five to 20 years, but you can take as long as 30 years to pay back a home equity loan.How do I get 20% equity in my home? ›
- Make A Big Down Payment. ...
- Refinance To A Shorter Loan Term. ...
- Pay Your Mortgage Down Faster. ...
- Make Biweekly Payments. ...
- Get Rid Of Mortgage Insurance. ...
- Throw Extra Money At Your Mortgage. ...
- Make Home Improvements. ...
- Wait For Your Home's Value To Increase.
Loan payment example: on a $100,000 loan for 180 months at 7.30% interest rate, monthly principal and interest payments would be $915.68 over the full term of the loan. Payment example does not include amounts for taxes and insurance premiums.What is the point of home equity? ›
Building home equity is important because it decreases your debt and increases the money you have stashed away in assets, which is a strong way to build financial stability. Beyond that, you can also leverage home equity to borrow money at a lower interest rate.How much equity can I take out of my house? ›
How much equity can I take out of my home? Although the amount of equity you can take out of your home varies from lender to lender, most allow you to borrow 80 percent to 85 percent of your home's appraised value.How much can I borrow from home equity? ›
How much can you borrow with a home equity loan? A home equity loan generally allows you to borrow around 80% to 85% of your home's value, minus what you owe on your mortgage. Some lenders allow you to borrow significantly more — even as much as 100% in some instances.How much is a $800,000 mortgage payment per month? ›
Monthly payments on an $800,000 mortgage
At a 4.5% fixed interest rate, your monthly mortgage payment on a 25-year mortgage might total $4,427.78 a month, while a 15-year might cost roughly $6,102.94 a month.
A home equity loan could be a good idea if you use the funds to make home improvements or consolidate debt with a lower interest rate. However, a home equity loan is a bad idea if it will overburden your finances or only serves to shift debt around.Is it better to have home equity or cash? ›
Cash-out refinancing tends to come with a lower interest rate than home equity loans. While home equity loans have lower closing costs, they are typically more expensive over time due to their higher interest rates.Can you borrow money against your house? ›
Home equity loans allow homeowners to borrow against the equity in their residence. Home equity loan amounts are based on the difference between a home's current market value and the homeowner's mortgage balance due. Home equity loans come in two varieties: fixed-rate loans and home equity lines of credit (HELOCs).