Key Takeaways
- Equity grows as you pay down your mortgage and home values rise.
- Use equity for home improvements, education, or debt consolidation.
- Home equity loans provide cash using your home's value as collateral.
- Equity isn't guaranteed; it can decrease if home values drop.
Article Summary
Equity, or home equity, is a homeowner's financial ownership in a property, calculated by subtracting the remaining mortgage balances from the home's value.
Home Equity: Explained in Plain English
Equity is the value of a homeowner's interest in their property. It's measured as the difference between the property's current market value and the amount still owed on any mortgages or liens against the property.
Home equity is the inverse of loan-to-value. When loan-to-value is 90%, home equity is 10%.
A homeowner's home equity increases in two ways only:
- Making mortgage payments that reduce the mortgage balance
- Home appreciation that increases the property's market value
Home equity is a powerful financial asset. Homeowners can use their home equity as collateral for home equity loans or home equity lines of credit (HELOCs). This can provide a source of cash for large expenses such as home renovations, education costs, or debt consolidation.
Equity is not guaranteed to increase in value over time. If home values drop, such as during the 2007-2009 financial crisis, homeowner equity decreases.
Since the mid-1970s, home values have increased by 5.11 percent annually, according to the Federal Housing Finance Agency's House Price Index, which tracks home price changes.
U.S. Homeowner Equity In Residential Real Estate (Billions)
FRED Data: OEHRENWBSHNO
Home Equity: A Real World Example
Consider a first-time home buyer using a low-down payment mortgage to buy their first home, specifically a 97% loan-to-value (LTV) conventional mortgage.
At closing, the homeowner's home equity is 3 percent.
Their lender explains that private mortgage insurance (PMI) will be necessary while home equity is less than 20 percent, corresponding to a loan-to-value of 80 percent. The lender anticipates the buyer will reach 20 percent equity in less than three years through regular mortgage payments and home appreciation.
After a few years, the first-time home buyer's equity exceeds 20 percent. They contact their lender, and the lender cancels PMI.
Common Questions About Home Equity
Get answers to the most frequently asked questions about home equity, including how it builds over time, how to use it for loans, and what happens when home values change.
What happens to my equity if the value of my home decreases?
If your home's value decreases, your home equity decreases. However, as long as you continue making mortgage payments, you reduce the amount owed, which can help build home equity.
Can I use my home's equity to pay for things?
Yes, you can access your home's equity by opening a home equity loan or a HELOC with your lender. Both options allow homeowners to borrow against their equity, often at lower interest rates than other types of loans.
Does making larger mortgage payments increase my equity faster?
Yes, making larger or additional payments on your mortgage principal can increase your equity more quickly, as it reduces the amount you owe on your home.
Is it possible to have negative equity?
Negative equity, also known as being "underwater" on your mortgage, happens when you owe more than your home is worth. When a homeowner tries to sell their home while it has negative equity, the homeowner must bring cash to closing to pay off the lien.
