- Personal Finance
- Mortgages
Some offers on this page are from advertisers who pay us, which may affect which products we write about, but not our recommendations. See our Advertiser Disclosure.
One of the most impactful reasons to own a home is to build equity. Home equity remains one of the most significant drivers of wealth in the U.S., according to the latest data from the Federal Reserve Board, and it’s the largest asset for many homeowners. But for it to work for you, you have to understand how home equity works and the best ways to use it.
-
MORE: See our picks for the best home equity loan lenders.
Home equity definition
Home equity is the portion of the property’s value that you own. If you pay cash for a home, you own 100% outright. But if you’re financing, like most home buyers do, you share ownership with the mortgage lender, and your equity builds over time.
How does home equity work?
When you first purchase the residence, your equity equals your down payment, which is the amount you pay in cash up front.
For example, if you make a 5% down payment on a $400,000 home, your initial equity is $20,000 (which is 5% of $400,000). You’ll continue to build equity in the home as you make monthly mortgage payments. You’ll reach 100% equity once you pay off the entire mortgage and own the house free and clear.
下一個
How to calculate home equity
To calculate the amount of equity you have in your home, take the current home value and subtract your outstanding mortgage balance.
Home equity = Current property value - Outstanding mortgage balance
For example, if your home’s current value is $475,000, and your outstanding mortgage balance is $300,000, you have $175,000 in home equity. This also means you have 36.84% home equity, and you still owe 63.16%.
You can find your loan balance on your latest mortgage statement. Determining your home’s value can be a bit more challenging.
A property’s value can change often, and it typically appreciates with time. For a recent estimate, use a home price estimator from real estate websites such as Redfin or Zillow. You can also schedule a professional home appraisal, but wait until you’re ready to access your equity, because you’ll have to pay for an appraisal.
How to access the equity in your home
You have several options when you’re ready to tap into your home’s equity. However, it’s crucial to note that unless you’re accessing the equity by selling the home, tapping into your home equity requires you to repay money later.
Here are common ways to access home equity while remaining in the house.
Home equity loan
With a home equity loan, you receive a lump sum of money and repay it at a fixed interest rate. You can apply with most traditional mortgage lenders.
Home equity loans typically require you to have at least 15% to 20% in equity, strong credit, and a low debt-to-income (DTI) ratio. Specific requirements vary by lender, but you can typically borrow up to 85% of your available equity and repay it during a term ranging from five to 30 years.
As a second mortgage, a home equity loan is secured by your property. So, if you can’t repay the loan, the lender has the right to foreclose on your home.
Home equity line of credit (HELOC)
Another type of second mortgage is a HELOC, which functions similarly to a credit card. You’re approved for a credit limit that you can access as often as you need to during the draw period.
A HELOC draw period can last up to 10 years and may require low, interest-only payments. After the draw period, you repay interest and principal across a 10- to 20-year repayment period.
“If you are looking at a remodel, a HELOC would be your best option because you have flexibility in the spending and the payment amount each month,” Pahmela Foxley, vice president of mortgage lending at Wasatch Peaks Credit Union, said via email. “Your payment is calculated on the balance you owe each month, not on the entire limit.”
Like credit card companies, HELOC lenders typically charge a variable interest rate, allowing your payment to fluctuate with market conditions. Unlike with credit cards, your home acts as collateral, so defaulting on payments puts your residence at risk.
Cash-out refinance
A cash-out refinance replaces your current mortgage with a new, larger one, and you pocket the extra cash. Because it’s a new loan, you’ll also take on a new interest rate and term length.
“A cash-out refinance may be an option if your first mortgage isn’t at a [record-low] rate,” said Foxley. “Make sure to research fees and rates and terms for the best fit for your financial situation.”
Repaying a cash-out refinance is similar to repaying your original mortgage. Even if you land a lower rate, the monthly mortgage payment may be higher since you’re borrowing more.
Reverse mortgage
Homeowners who are 62 years or older can borrow their equity as a lump sum, as a line of credit, or in fixed disbursements with a reverse mortgage.
To qualify for a reverse mortgage, you typically must own the home outright or have paid off a substantial amount of your initial home loan. However, unlike a home equity loan or HELOC, you don’t have to repay it in monthly installments. Instead, you pay back a reverse mortgage once you move out, sell the home, or pass away. This can be costly because interest accrues and is added to the principal as long as the balance is outstanding.
Shared equity agreement
A shared equity agreement, also known as a home equity contract or home equity investment (HEI), is a contract between a homeowner and a company other than a traditional mortgage lender. The company offers money up front in exchange for a stake in the home’s future value.
Homeowners don’t make monthly payments. Instead, they owe the full balance at the end of the contract — typically in 10 to 30 years. The repayment balance is based in part on the home’s value, which could appreciate significantly over the years. If the homeowners can’t make the payment, they may be forced to sell their home or risk foreclosure.
A shared equity agreement may look attractive because it comes with laxer income and credit requirements. However, this option can be significantly more expensive than more traditional methods.
-
Reverse mortgage vs. home equity loan vs. HELOC: Which is best?
The best ways to use home equity
Once approved for one of the above home equity options, you can generally use the funds however you want. Here are some common strategies:
-
Cover home repairs
-
Make value-enhancing home renovations
-
Pay off high-interest debt
-
Cover significant emergency expenses or build an emergency savings fund
-
Pay for education costs
Just remember, it’s not free money. You must repay it, either with added interest or as a portion of the home’s value, so you’ll want to use the funds wisely.
“Using home equity to reinvest in your property is often considered the best use, as it can increase the home's value,” said Foxley.
She noted that home improvements aren’t guaranteed to boost your home’s value, though. ”Once you do a renovation, you may not get that value back when you sell the home — or just a fraction of the cost you spent on the remodel.”
-
Learn which home improvements are tax-deductible.
Pros and cons of tapping home equity
However you access the equity in your home, it’s worth understanding the benefits and drawbacks before moving forward.
Pros
-
Lower rates: Home equity loans and HELOCs typically have lower interest rates than other borrowing options, such as personal loans and credit cards.
-
Spending flexibility: You can generally use home equity funds however you choose.
-
Potential tax benefits: Homeowners may be able to deduct the interest paid on HELOCs and home equity loans if the money was used to buy, build, or make substantial improvements to the home.
Cons
-
Foreclosure risk: Because you’re using the home as collateral, it’s important to stay current with payments — otherwise, you could lose your home.
-
Closing costs and fees: You may need to pay closing costs similar to those incurred with the original mortgage, such as origination, appraisal, and credit report fees.
-
Fluctuating payments: HELOCs, in particular, have variable rates, so it’s possible your payments may increase over time.
How to increase the equity in your home
You build home equity when the property value increases or the mortgage balance decreases. Investing in home improvements, making extra payments toward the mortgage principal, or simply allowing the property to appreciate over time are all common ways to increase your home’s equity.
-
Here are 7 ways to pay off your mortgage faster.
Home equity FAQs
Can you take equity out of your home without refinancing?
Yes, you can access your home’s equity with a home equity loan or HELOC. These are two types of second mortgages, so neither requires you to refinance your original mortgage.
Do you have to pay back equity?
Generally, yes. Common equity borrowing methods, such as a HELOC, home equity loan, or cash-out refinance, require you to repay the balance with interest, typically through monthly payments. Homeowners with a reverse mortgage will repay the balance once they move, sell, or pass away.
Is it a good idea to tap into the equity in your home?
Using your home’s equity can be a smart way to fund projects that’ll significantly increase the property’s value or improve your financial situation, such as paying off high-interest debt. However, you use your home as collateral when you borrow against it, which puts it at risk of foreclosure if you’re unable to repay.
Laura Grace Tarpley edited this article.
閱讀更多
How to use home equity to build wealth: Strategies and risks
You can use your home equity to build wealth by taking out a home equity loan or line of credit. Learn how to use these tools to become wealthier.
How and when do you pay back a reverse mortgage?
Paying back a reverse mortgage is necessary upon death or selling the home, and there are ways to repay the funds early. Learn more about your options.
What do you need to qualify for a home equity loan? Here are the requirements.
Home equity loan requirements include a good credit score, sufficient equity in your home, and more. Learn whether you qualify for a home equity loan.
Can you use a HELOC for a down payment?
Using a HELOC for a down payment on a second home has its advantages and disadvantages. Learn how it works, who’s eligible, and when it makes sense.
