Home equity is the difference between what your home is worth and what you owe on your mortgage. Think of it as the portion of your home that you own outright.
Home equity represents a significant percentage of most Americans’ net worth.[1] It builds your wealth, increases your financial security, and can be leveraged with a home equity loan or line of credit to make improvements on your home or tackle other financial goals.
Here's everything you need to know about building equity, calculating it, and whether you should tap into it.
How does home equity work?
Home equity grows over time. Each mortgage payment you make increases equity in your home. When you start paying off a mortgage, most of your payment will go toward interest. As you continue to make mortgage payments, the proportion of your monthly payment that goes toward reducing the principal balance increases, helping you build equity faster.
Equity can also increase when your home’s value goes up. Your home’s value can change either because of market appreciation or due to improvements you make. For example, if your neighborhood becomes more desirable and home prices rise, your equity goes up. And if you remodel your kitchen or improve curb appeal, your property’s value may go up, boosting your home equity.
How to calculate your home equity
To calculate your home equity, you need to get an estimate of your home’s value by comparing recent sale prices of homes similar to yours in your area or get it appraised by a professional and subtract the remaining mortgage balance.
Home equity = Current home value - Mortgage balance
Let’s say your current home value is $500,000 and your mortgage balance is $350,000. Your home equity is $150,000.
How to build home equity
Building home equity takes time. If you want to build equity faster, here are four of the best ways to accelerate growth.
Make a big down payment
One of the fastest ways to build equity is by putting down as much as you can. For example, if you buy a $400,000 home and put down 20%, you’ll have $80,000 equity immediately.
A large down payment also helps you avoid mortgage insurance (MI), which can add extra costs to your loan.
If you’re years away from buying a home, save aggressively for a larger down payment. The equity advantage compounds over time.
Pay more than the minimum
The standard mortgage payment follows an amortization schedule. But that shouldn’t stop you from paying extra toward the principal.
Making extra payments toward the principal can help you build equity faster. Even an extra $100 or $200 a month can make a big difference over time.
Make home improvements that add value
Upgrading your home can increase its market value and, in turn, your equity. However, not all home improvements add value.
Focus on improvements with the highest return on investment (ROI), such as bathroom remodels, kitchen updates, energy-efficient upgrades, or curb appeal enhancement.
The timing matters, too. Home values in improving neighborhoods multiply renovation returns, while declining areas limit how much value you can add.
Stay in the home and wait for the value to rise
Property values tend to go up over the long term. Simply staying put allows you to benefit from home appreciation.
As you pay down your mortgage and property values rise in your area, you increase your home equity over time.
Ways to tap your home equity
Your home equity is a finance tool you can use to help you accomplish other financial goals. Once you’ve built enough equity, here are several ways you can make good use of it.
Home equity loan
A home equity loan is a second mortgage that you can secure using the equity you’ve built in your house. It’s often a lump sum amount with a fixed interest rate paid over a specific period of time.
This option is perfect for home renovations, debt consolidation, or one-time expenses like tuition or medical bills.
Home equity line of credit (HELOC)
A HELOC is secured by a home’s equity and works like a credit card. You’re approved for a set credit limit, and you can withdraw as much as you want for a set period, usually 10 years.
You'll only pay interest on what you actually borrow, and the rate is usually variable, meaning it changes over time.
Cash-out refinance
A cash-out refinance replaces your existing mortgage with a new larger mortgage, and you pocket the difference.
Like any refinance, your new mortgage pays off the old one, so you have one monthly mortgage payment. Remember that you can’t cash-out refinance your entire home equity; you’ll likely need to leave at least 20% in equity untouched in order to qualify for a new mortgage.
Reverse mortgage
This is an option for homeowners aged 62 and above. Unlike home equity loans and HELOCs, where you’ll need to make monthly payments, the lender pays you each month instead while you continue to live in the home. However, you must repay the loan when you sell the home, vacate, or pass away.
Curious what you could get for your home if you sold it today, as-is? Clever Offers can introduce you to investors in your area who are ready to close (with cash) ASAP.
Pros and cons of borrowing against your home equity
Pros
- Lower interest rates
- Flexible use
- Potential tax deductions
Cons
- Risk of losing your home
- Additional borrowing costs
- You may owe more if home values drop
- Additional debt obligations can strain finances
Tapping your home equity has several benefits, but it’s not without risks. Weighing the upside and downsides can help you decide whether you’re making a smart move.
Because your home acts as collateral for the new loan, you appear less risky in the eyes of lenders. For this reason, you’ll likely pay less in interest, which can save you thousands. You can use home equity funds to cover any expense you want.
If you use a portion of the money to cover home improvements, you may qualify for a deduction in the interest you pay on taxes. This can reduce how much you owe the IRS at the end of the year.
On the flip side, home equity loans, HELOCs, and cash-out refinances uses your home as collateral. If you stop making those payments, your lender can foreclose.
Like any other mortgage, you’ll need to pay closing costs, which could cost you thousands upfront. And if home values drop in your area, you could owe more than what your home is worth. This can make it difficult to sell the property when you want to.
If you get a home equity loan or line of credit, then you’ll end up with two monthly payments, which can be challenging to keep up with. A cash-out refinance means a higher monthly mortgage payment, so you’ll want to make sure you can manage those higher payments on your current budget.
Is tapping into your home equity a good idea?
Some uses of home equity are more financially solid than others.
Smart ways to use your home equity include leveraging it for home renovations that will increase the home’s value, paying off high-interest debt, or funding educational or other major life expenses.
You might also use your current home’s equity to invest in another property, such as a rental home that will generate long-term income for you.
It’s not a good idea to use equity for nonessential purchases, or to borrow against your home equity in a declining market. Taking on new debt without a repayment plan is something you should guard against, especially because if you can’t make payments, you could lose your home.
Consulting a financial advisor or a real estate professional before borrowing is always a good plan. Clever can help connect you with agents in your area who can help you understand the benefits and drawbacks of using your home’s equity.
The bottom line
Home equity represents one of the most valuable forms of personal wealth, and it typically grows over time through responsible ownership and appreciation.
If you’re thinking about using your home’s equity, first calculate your current equity (an agent can help with this) and then explore the best ways to use it strategically.
Ready to find out how much equity you’ve built? Clever can match you with a trusted local agent who’ll run a free home valuation and help you make the most of your property’s potential. Take a short quiz to get started.
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FAQ
Is it a good idea to take equity out of your house?
It depends on how you use it. If you’re using it for home improvements that raise property value or to consolidate high-interest debt, it can be beneficial. But using it for short-term wants, like vacations, it may not be a good idea.
Does equity have to be paid back?
Home equity itself doesn't require repayment since it’s the portion of your home you own. But if you borrow against your equity through a loan, HELOC, or refinance, you must repay those borrowed funds with interest.
What is the downside to a home equity loan?
The main downside is the risk of losing your home. You're using your home as collateral, so failure to repay can result in foreclosure.
What can you do with home equity?
There are no restrictions. You can use home equity to consolidate debt, do home improvements, start a business, pay for education, cover medical bills, and any other expense.
Can I pull out equity from my house without refinancing?
Yes, home equity loans and HELOCs let you borrow against equity without touching your existing mortgage. You'll have two separate loans, each with their own payments and terms.
Is a home equity loan a second mortgage?
Yes, a home equity loan is considered a second mortgage because it’s an additional loan secured by your property, separate from your primary mortgage.