Home Equity

What is home equity?

Updated April 15, 2022

Your equity is whatever portion of your home’s value you’ve already paid off—the difference between the home’s current value and the amount you owe on your mortgage. So if a homeowner purchases a property valued at $1 million, and makes a 20% down payment, their equity in the home is $200,000. 

Building equity 

Naturally, the larger your down payment, the larger your equity. Note that equity will change over time, as you pay off more of your loan and therefore own larger portions of the home. It will also change as the home’s market value fluctuates, and homeowners will see their equity grow if their property appreciates over time.

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For example, if a homeowner who bought their house for $1 million sees the property’s value rise to $1.2 million, and they still owe $800,000, their equity has increased from 20% to 33%. Unfortunately, during economic downturns, equity can also decline along with home values. The longer you stay in your home, the likelier it is your home’s value will go up and your equity will in 

Buying a home is a way to build equity. The smaller the mortgage, the more equity you have in your home. Credit: Sigmund/Unsplash

In addition to appreciation, homeowners boost their equity by paying off their mortgage. Over time, a larger portion of these repayments will go toward the loan’s principal, rather than interest, and the more that goes toward principal, the faster equity builds. You can increase your equity even faster by making larger or more frequent mortgage payments. 

Home renovations and upgrades can also improve your home’s value, and therefore your equity. 

Using equity

Building equity means building wealth, and it’s an asset you can use in a number of ways. 

Equity could help you upgrade to a larger home. Depending on how much your home has appreciated—and how much of your mortgage you’ve paid off—you may be able to sell your home for enough to pay off the rest of the mortgage, cover closing costs and earn a profit, thanks to your equity. This profit could then allow you to make a bigger down payment on a new home. 

Older homeowners have the option of taking out a reverse mortgage, which means stopping mortgage payments and instead receiving payments out of their home equity. This could be used to fund retirement. The loan is eventually repaid by profits from selling the house. If the homeowners pass away, their heirs decide what to do; they, too, can opt to sell the home and pay off the mortgage balance with the proceeds, or they could keep the home and take on mortgage payments themselves.

There are risks to this: If you decide to move and are unable to pay off your mortgage, your mortgage lender can foreclose on the home. 

Home equity loans 

Some homeowners opt to borrow money against their equity in the form of home-equity loans, which are usually lump sums of cash. Borrowers might use this money for large, one-time purchases, like renovations, weddings and so on. You can only borrow up to the total amount of equity you have. 

There are downsides and risks: You are essentially taking out a second mortgage, and will have to pay closing fees on the loan. It’s another monthly repayment you’ll be responsible for, and foreclosure is a possibility if you’re not able to pay it off on schedule. On the other hand, these loans can be easier to take out than others, and you can lock in a low interest rate, just as you would with a regular mortgage. You can also claim a tax deduction for the interest you pay on the loan. 

A home equity line of credit, or Heloc, is a line of credit that lets you borrow against your equity, and you can withdraw and repay funds just as you would with a credit card—although the interest rates tend to be lower. If you’re approved for a Heloc, you may have a draw period—a specific length of time during which you can withdraw and repay funds, often 10 years. Helocs may make more sense for homeowners who need to borrow money on a regular basis (e.g. for college tuition payments) or who are temporarily out of work. But note that they come with their own set of fees, and as with standard home equity loans, you run the risk of foreclosure if you find yourself unable to make repayments on time.