What Is Home Equity and Why Is It Important?

Have you ever been told you can “take money out of your house” to do renovations or pay for college? What does this mean, and is it really possible?

It is — as long as you have equity in your home.

Let’s demystify this confusing homeownership term and learn what exactly you can do with your home equity.

What Is Home Equity?

When you buy a home, you’re not just investing in a place to live; you’re also building an asset. Over time, that asset grows in value, and as you pay off your mortgage, you accumulate something called home equity.

In simple terms, home equity is the portion of your home that you truly own. It’s the difference between your home’s market value and the amount you owe on your mortgage. As you make mortgage payments, your equity increases. As the value of your home rises, your equity can grow as well.

Formula to calculate your home equity is straightforward

The current market value of the home minus the remaining mortgage balance equals your home equity.

For example, if an appraiser deems your home is worth $250,000 and you owe $150,000 on your mortgage, you have $100,000 in home equity.

In this example, you own $100,000 worth of your home, and the rest is still owned by the bank or lender until you pay off your mortgage.

Why Is Home Equity Important?

Home equity isn’t just a number. There are many ways you can use home equity to your advantage.

1. Home equity loan

A home equity loan is essentially a second mortgage. It allows you to borrow money — up to a certain share of your equity in your home — at a set interest rate over a period of a few years.

2. Cash-out refinance

With a cash-out refinance, you get an entirely new mortgage — but you get to keep a portion of your equity in cash. You can use this cash for renovations, college tuition, medical bills, or anything you choose.

3. Home Equity Line of Credit (HELOC)

There are also home equity lines of credit in which a lender extends a line of credit for a set number of years. You have the flexibility to borrow up to your credit limit for the first period of the loan, usually about 10 years.

Homeowners should be careful with home equity lines of credit because they can lead to bad spending habits and even more debt. They are not offered by every lender.

How Does Home Equity Grow?

There are two primary ways your home equity increases — you pay down your mortgage and the value of your home appreciates.

As you make mortgage payments, your equity increases. Another good way to build equity is to make extra mortgage payments on your principal occasionally. This will reduce the principal balance on your loan and give you a higher amount of equity.

You can also make value-adding renovations and upgrades to your home. If these increase your home’s value significantly, it will also increase your equity.

And as we mentioned, general price appreciation helps — as the value of your house increases so does your equity. If your local housing market is booming, your neighborhood gets new amenities, the schools improve, or buyer demand is up, your home’s value can rise. And a higher value means more equity and more access to cash.

Something to Think About Before Using Your Equity

If you’re considering a home equity loan or other equity product, make sure you know what’s at stake. On these loans, your home is the collateral — meaning if you can’t repay that loan, your home can be foreclosed on (even if it’s not your first mortgage).

Always ask for a full estimate of costs for any home equity product you’re considering. Make sure you know your monthly payment and other financial obligations, and look at your budget to ensure you can comfortably cover those expenses before putting your house on the line.

Want to Tap Into Your Equity?

Are you considering using your home equity to fund home improvement projects or pay your child’s college tuition?

Do you just want to know how much equity you have access to? Speak to a loan officer at Embrace Home Loans today.