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What is home equity?

How much of your home is really yours?

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Homeownership lets you use your money on an asset that’s likely to increase in value over time. For many Americans, buying a home is a way of investing in the future.

Though most home purchases are financed through mortgages, homeowners can still benefit from rising home prices. Equity, which is the value of the owner’s stake in the home, is a valuable portion of your investment — and you can use equity for a variety of purposes.

Key insights

  • Your equity is your home’s current value minus your outstanding mortgage balance.
  • You build equity as you make mortgage payments.
  • You can take out a home equity loan or HELOC to access the equity you’ve built.

What does equity mean in real estate?

In real estate, equity is essentially the portion of a property’s value you own after making payments. Since most homeowners need a mortgage to buy real estate, equity helps owners determine their share of the investment.

As you make mortgage payments over time, your equity increases until the loan is paid in full. Once you’ve paid off the mortgage, you’ll have 100% equity in the home.

How does equity work?

When you buy a home, most lenders require some form of down payment (an upfront cash payment calculated as a percentage of the home’s sales price), which gives you equity from the beginning.

Lenders set this requirement because, from the bank’s point of view, a borrower who establishes more equity at the beginning of a loan is more likely to pay back what they borrowed. In other words, once a borrower has a significant financial stake in the property, they’re less likely to default on their loan.

You’ll also add to your equity throughout the loan term as you make monthly payments. With an amortized loan, you’ll pay back your debt as monthly payments that include both principal and interest. In the first few years, the payments you make will contribute mostly to interest and will only pay off a small portion of the principal.

However, as time passes, you’ll pay off more and more of the principal. This increases your equity stake in the home.

How to calculate equity

The amount of equity you have depends on the home's current value. The general formula for calculating equity is: Current value of the property - outstanding mortgage loan balance = home equity.

Equity =
current property value -
remaining mortgage balance.

For example, say your home recently appraised for $350,000. Your outstanding loan balance, or the amount you still owe on your mortgage, is $200,000 — so you have $150,000 in equity. If you were to sell your home for $350,000, you would pay off your loan and your end of the closing costs, then keep the remaining proceeds from the sale.

As a general rule, your equity increases as your home's value rises. However, you may not see the benefits until you actually sell your home. There are online calculators available to help you estimate your equity, but you might get a more accurate value by requesting a home appraisal, which usually costs between $200 to $600.

Keep in mind that home values fluctuate based on market circumstances. Your home may have a high estimated value in a seller’s market, which is when the demand for homes is higher than the supply.

Just a few short years later, however, the housing market could slow down and the value of your home could fall. For the most part, though, home prices tend to rise over time, so you can usually count on your equity growing.

How to use the equity in your home

Once you have some equity, you can utilize its value to borrow money. These funds can help to make home improvements, pay off (or consolidate) other debts or pay for a child’s college tuition, for instance.

Home equity loans and HELOCs

A home equity loan lets you borrow a specific amount with a fixed interest rate. Home equity loans generally offer low interest rates (compared with credit cards or personal loans) because the loan is backed by collateral (your home). If you’re looking to make some improvements to your home, like remodeling your kitchen or finishing a basement, a home equity loan can be a great option.

You could also get a home equity line of credit (HELOC), which is another way to draw from your equity for funds. A HELOC also uses your home as collateral but is different from a home equity loan — it’s revolving credit, so the funds aren’t distributed upfront. Instead, you can withdraw funds up to your limit over a period of (usually) five to 10 years.

You may choose a HELOC if you anticipate having to pay irregular expenses in the short term. Keep in mind that your home is the collateral for home equity loans and HELOCs, which means you could lose it if you stop making payments.

Reverse mortgages and refis

You can also access your equity through a reverse mortgage or a cash-out refinance. A reverse mortgage is a loan for homeowners age 62 or older, like one reviewer on our site from California, who accessed their equity with a reverse mortgage to help make it through retirement.

With this type of mortgage, you can receive the equity as a lump sum, in fixed monthly payments or as a line of credit. However, reverse mortgages can be complicated, and there are significant financial risks involved.

Another option is to replace your existing mortgage with a cash-out refinance. A cash-out refinance essentially replaces your old mortgage with a new loan that is larger than what you currently owe. However, you can use this new loan to turn equity into an upfront cash payment.

It’s important to remember that reverse mortgages and cash-out refinances require you to pay closing costs, so you’ll want to consider this additional expense before your borrow.

What is sweat equity?

It’s typical for homeowners to make home improvements in hopes the changes will increase the value of their homes (and increase their equity). For instance, you may build a small patio or repaint your interior walls with a neutral color to sell your home for a slightly higher price. When homeowners are able to make improvements themselves, they can both save money and build equity — hence the term “sweat equity.”

However, keep in mind that some projects should be left up to the professionals, especially if you don’t have any experience. Before you start knocking down walls or tearing down a rotting deck, you may want to consult with a licensed contractor to get a better understanding of what the project entails. You could end up causing damage that’s significantly more expensive to repair than it would have been to hire a professional in the first place.

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    Bottom line

    If you’re a homeowner, equity is the value of your stake in your property. It’s a good idea to keep track of how much equity you’ve built over time as you make payments on your mortgage because you may be able to access your equity to get a low-interest loan.

    As home values fluctuate, your equity will also change. You can still use equity strategically to accomplish your financial goals, but you’ll want to be aware of the timing.

    For example, you may choose to refinance your existing loan when prices are at their highest and interest rates are low. Depending on the current appraised value, you may be able to drop private mortgage insurance payments once you’ve reached 20% equity.

    On the other hand, if home values have plunged in the short term and you don’t have at least 15% equity, you may not be able to qualify for a HELOC until the market has recovered.

    ConsumerAffairs writers primarily rely on government data, industry experts and original research from other reputable publications to inform their work. To learn more about the content on our site, visit our FAQ page.
    1. U.S. Census Bureau and U.S. Department of Housing and Urban Development (HUD), retrieved from FRED (Federal Reserve Bank of St. Louis), “Average Sales Price of Houses Sold for the United States.” Accessed April 30, 2022.
    2. Consumer Financial Protection Bureau (CFPB), “How much will a reverse mortgage loan cost?” Accessed April 30, 2022.
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