What is Equity?

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.

A Longer Definition: Equity

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:

1. Paying down the principal balance and money owed on the home
2. Appreciation of the property’s value

Home equity is a powerful financial asset, and homeowners can use their home equity as collateral for home equity loans or home equity lines of credit (HELOCs) and as a source of cash for large expenses such as home renovations, education costs, and debt consolidation.

Equity is not guaranteed to increase in value over time. When home values drop, such as between 2007-2009, homeowner equity decreases.

Periods of decreasing home values are rare.

Home values have increased by 5.11 percent annually since the mid-1970s when the Federal Housing Finance Agency launched its House Price Index, which tracks home price changes.

Equity: A Real World Example

First-Time Home Buyer Stories: Equity

Consider afirst-time home buyer using a low-down payment mortgage to buy their first home – specifically a 97% LTV conventional mortgage.

At closing, the homeowner’s home equity is 3 percent.

Their lender explains to the buyer that private mortgage insurance will be necessary while their home equity is less than 20 percent, corresponding to a loan-to-value of 80 percent. The lender anticipates the buyer will reach twenty percent equity in less than three years through regular mortgage payments and expected home appreciation.

After a few years, the first-time home buyer’s equity exceeds 20 percent. They contact their mortgage lender, and the lender cancels PMI.

Common Questions About Equity

What happens to my equity if the value of my home decreases?

If your home’s value decreases, your home equity decreases as well. However, as long as you continue making mortgage payments, you are reducing the amount you owe which can also 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. Because mortgages are due on sale, when a homeowner tries to sell their home, and it’s underwater, the homeowner must bring cash to closing to pay off the lien.