What Is Home Equity?
Home equity is the value of a homeowner’s interest in their home. In other words, it is the actual property’s current market value (less any liens that are attached to that property). The amount of equity in a house—or its value—fluctuates over time as more payments are made on the mortgage, and market forces impact the property's current value.
- Home equity is the current market value, minus any liens, like a mortgage, of your home.
- You leverage your home equity in the form of collateral to tap into cash in the form of a home equity loan or a home equity line of credit.
- When you put a down payment on a house of 20% or more, you are automatically adding to your equity in the home.
- A smaller downpayment means a larger mortgage, and less home equity right off the bat.
- The equity in your home may fluctuate for many reasons, including the rise and fall of overall market value in your community.
How Home Equity Works
If a portion—or all—of a home is purchased via a mortgage loan, the lending institution has an interest in the home until the loan obligation has been met. Home equity is the portion of a home's current value that the owner possesses at any given time.
Equity in a house is initially acquired with the down payment you make when you buy the property. After that, more equity is achieved through your mortgage payments since a contracted portion of that payment will be assigned to bring down the outstanding principal you still owe.
You can also benefit from property value appreciation because it will cause your equity value to increase.
Home equity is an asset and it is considered a portion of an individual's net worth, but it is not a liquid asset.
Home Equity Loan vs. HELOC
Unlike other investments, home equity cannot be quickly converted into cash. Why? Because the equity calculation is based on a current market value appraisal of your property. And that appraisal is no guarantee that the property would sell at that price.
However, an owner can leverage their home equity as collateral to secure either a home equity loan or a home equity line of credit (HELOC) or fixed-rate HELOC, a kind of home equity loan and HELOC hybrid.
A home equity loan, sometimes referred to as a second mortgage, usually allows you to borrow a lump sum against your current home equity for a fixed rate over a fixed period. Many home equity loans are used to finance large expenditures, such as home repairs or college tuition.
A home equity line of credit (HELOC) is a revolving line of credit, usually with an adjustable interest rate, which allows you to borrow up to a certain amount over a period of time. HELOCs work like credit cards, where you can continuously borrow up to an approved limit while paying off the balance.
Mortgage lending discrimination is illegal. If you think you've been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report to the Consumer Financial Protection Bureau or with the U.S. Department of Housing and Urban Development (HUD).
Example of Home Equity
If a homeowner purchases a home for $100,000 with a 20% down payment (covering the remaining $80,000 with a mortgage), the owner has equity of $20,000 in the house. If the house's market value remains constant over the next two years, and $5,000 of mortgage payments are applied to the principal, the owner would possess $25,000 in home equity at the end of the two years.
If the home's market value had increased by $100,000 over those two years, and that same $5,000 from mortgage payments were applied to the principal, the owner would then have home equity in the amount of $125,000.
What Is a Home Equity Loan?
A home equity loan is money that is borrowed against the appraised value of your home. You receive the funds in a lump sum, and you are required to make monthly payments, like any other type of loan. Basically, a home equity loan is a second mortgage on your house.
How Can I Get a Home Equity Loan?
You can get a home equity loan by contacting a lender who offers these types of loans. The first step is to get a professional appraisal of your home to find out its market value. If you have enough equity in your home to take out this type of loan, a lender will also check your credit and debt-to-income ratio. If you qualify for a home equity loan, your loan funds are usually delivered in a lump sum after the closing. Home equity loans are essentially a second mortgage on your house, with fixed-rate monthly payments.
What Is a Home Equity Line of Credit?
A home equity line of credit (HELOC) works similar to a credit card, acting as a revolving line of credit based on your home's equity. HELOC funds can be used when you need them, paid back, and used again. Often there is a 10-year draw period, where you can access your credit as needed, with interest-only payments. After the draw period, you enter the repayment period, where you must repay all the money you borrowed, plus interest.
How Much Equity Do I Have on My Home?
You gain equity in your home by paying down the principal in your mortgage over time. If you used a downpayment to purchase your home, you likely have some equity in it, and with each mortgage payment, your equity grows. To figure out how much equity you have in your home, divide your current mortgage balance by the market or recently appraised value of your home.