What’s home equity? Your guide to building and using wealth

What you’ll learn ✅

— What home equity is and how it works

— How to calculate your home equity to understand your ownership stake

— How to get equity out of your home with home equity loans, HELOCs, or cash-out refinances

Home equity is the difference between your mortgage balance and the current market value of the property, often expressed as a percentage. It measures how much of your home is truly yours instead of your mortgage lender’s.

Owning a home is like having a giant piggy bank you’re required to add to each month. And even though you contribute regularly, it can take some elbow grease to access it. However, there are ways to use the stored value without resorting to breaking out the hammer.

This guide explains what home equity is. By the end, you’ll understand how home equity works and how to access it.

What does home equity mean?

Home equity measures how much of your home you own outright by comparing the property’s market value to how much you still owe on your mortgage.

Your starting home equity is based on your down payment. If you put 20% down on a $500,000 home, your initial home equity is $100,000, or 20%. Your lender’s financial interest is $400,000, which comes to 80%.

But how does home equity work to increase your stake in the property? As you make payments toward the principal on your mortgage, your home equity grows by lowering the remaining debt you owe and chipping away at your lender’s financial interest.

How does home equity build up over time?

There are a few different mechanisms that make your home equity go up (or down). These include:

— Market movements: Home equity fluctuates with the housing market. When housing prices go up, your home is worth more, but your outstanding mortgage balance remains the same. That means your equity increases. If prices go down instead, your equity goes down with it. While the housing market can be volatile, the average home appreciation per year is 3.5–3.8%, which means your equity should (hopefully) grow steadily over the long term.

— Mortgage payments: Every time you make a principal payment to your lender, you’re reducing your mortgage balance, which increases your home equity. Making extra payments toward your principal can help you build equity faster.

— Home improvements: Smart renovations can boost the market value of your home, which adds to your home equity.

How to calculate your home equity

Calculating your home equity is relatively straightforward. First, follow these steps:

— Estimate your home’s market value: If you have a recent appraisal, that’s likely the most accurate source. Otherwise, use real estate websites to see how much similar properties in your area are selling for.

— Find your remaining mortgage balance: Check your last mortgage statement to find out how much you still owe. If you have additional loans against your home, such as a home equity loan or a home equity line of credit (HELOC), add those balances in, too.

Once you find these numbers, plug them into the following equation:

Home equity = Market value − Remaining mortgage balance

Let’s take a look at a simple example to illustrate how this works. Suppose you purchased a property for $400,000 with a 10% down payment of $40,000. That’s your starting home equity, and your remaining balance is $360,000.

Now, imagine the home has appreciated to $450,000, and you’ve paid down an additional $20,000 of the principal. This means your mortgage balance has fallen to $340,000. Doing the math, we find:

Home equity = $450,000 - $340,000 = $110,000

Expressed as a percentage, you now have just under 25% equity in your home.

How can I use the equity in my home to improve my finances?

Here’s how to use home equity to spruce up your financial profile.

Eliminating private mortgage insurance (PMI)

Private mortgage lenders typically require borrowers who put down less than 20% to pay for PMI. This protects their investment if the homeowner can’t make the payments. Once you reach 20% equity, you can ask your lender to cancel it. With PMI averaging 0.46–1.50% of the initial loan amount every year, eliminating it can save you a bundle.

Consolidating debt

If you have high-interest debt accounts like credit cards and personal loans, borrowing against your home’s value can help you pay them off. HELOCs and cash-out refinances are two common ways to do this.

You’ll need a good credit profile to make sure your new interest rate is lower than your old one. Keep in mind that swapping unsecured debt for a loan that uses your home as collateral increases your risk of foreclosure.

Planning for retirement

If you’ve built up a lot of home equity, selling your home can give you a cash infusion. These extra funds can cover everyday expenses or build an emergency fund, huge assets once you’re no longer working. After selling, you may want to downsize or move to an area with a lower cost of living so you’re not on the hook for an equally high mortgage.

What can I do with the equity in my home? Mortgage options

Home equity is considered an illiquid asset. That means you can’t quickly convert it to cash like you can with stocks or bonds. If you want to access your equity, you either have to sell your home or take advantage of certain mortgage options. Here’s how equity works with home loans to tap into your equity.

Cash-out refinances

Cash-out refinances replace your mortgage with a bigger one. You use this loan to pay off the first mortgage and pocket the remainder.

Better offers cash-out refinances with zero origination, application, or underwriting fees, and no surprises hidden in the paperwork. It’s fast, too. You can get pre-approved to see your personalized interest rate in as little as three minutes.

...in as little as 3 minutes – no credit impact

Home equity loans

Home equity loans let you borrow against your home equity to get a lump sum of cash. They typically come with a fixed interest rate, and you pay them back over a set term like your original mortgage.

These loans are one of the most popular options for people who don’t want to refinance. They’re a type of second mortgage because they use your home as collateral. Unlike a refinance, they stack on top of your current mortgage instead of replacing it.

Home equity lines of credit (HELOCs)

HELOCs are occasionally referred to as “home equity accounts.” But what’s a home equity account, exactly?

This loan is also a type of second mortgage. Instead of providing a lump sum, however, HELOCs open a line of credit based on the value of your home that you can draw from as needed, much like a credit card.

HELOCs have a draw period that typically lasts up to 10 years. During this time, you only have to make payments on the interest for any funds you’ve taken out. After the draw period, the repayment period begins, which can last up to 20 years. Once the repayment period starts, you can no longer take out funds.

If you qualify for a HELOC, you might use it to consolidate debt, fund a major renovation, or even purchase a second home.

Pros and cons of borrowing against your home equity

There are many ways to cash in on the equity in your house — but should you use them? Here’s a look at the advantages and potential drawbacks to help you decide.

Pros

— Lower interest rates: If your credit profile has improved since you took out your original mortgage, refinancing can help you land a better rate. Free mortgage calculators make it easy to estimate your new monthly payments to see how much you might save.

— Flexibility: There aren’t any restrictions on what you can use the unlocked funds for.

— Tax benefits: If you use funds to buy, build, or substantially improve your home, you may be able to deduct the interest payments.

Cons

— Less equity: Borrowing against your home equity reduces how much you have since it increases your debt load.

— Risk of foreclosure: Putting your home up as collateral means you could lose it if you can’t make the payments.

— Closing costs: These fees eat into your unlocked funds.

Why building home equity matters

Building your home equity provides a slew of tangible benefits, such as:

— Increasing your net worth

— Making it easier to qualify for home equity loans, HELOCs, and cash-out refinances

— Cushioning the blow if the housing market crashes

— Lowering the total amount of interest you have to pay

Partner with Better to tap into your home equity the easy way

Home equity is a potent part of your financial toolkit. It gives your money a safe harbor and grows with every monthly mortgage payment.

If you need to tap into these funds, try Better. We offer home equity loans, HELOCs, and cash-out refinances. You could apply in as little as three minutes to see your personalized rate and get the ball rolling.

Unlock your equity hassle-free with Better.

...in as little as 3 minutes – no credit impact