Home Equity: What It Is and How It Works

What is home equity?

Home equity is the portion of a property’s market value that you truly own. Calculate it as:

Equity = Current market value of the home − Outstanding liens (for example, mortgage balances)

Equity grows when you pay down principal or when the property appreciates. It shrinks if the property falls in value or if you borrow against it.

How home equity works

• A mortgage lender holds a lien on the property until the loan is paid off.
• Your down payment gives you immediate equity at purchase.
• Each mortgage payment typically reduces principal (increasing equity) and pays interest.
• Appreciation of the home’s market value also increases equity.
• Equity is an asset but not liquid — converting it to cash typically requires a loan or sale.

How to calculate your equity (simple example)

1. Estimate your home’s current market value (e.g., recent comparable sales).
2. Subtract your outstanding mortgage balance.

Example:
– Home value: $350,000
– Mortgage balance: $150,000
– Equity = $350,000 − $150,000 = $200,000

Ways to borrow against equity

Common methods to access home equity, usually at lower rates than unsecured credit because the loan is secured by the property:

• Home equity loan (second mortgage): Lump-sum loan with fixed payments and a fixed rate. Good for one-time expenses.
• Home equity line of credit (HELOC): Revolving credit line, typically variable rate, usable over a draw period and repaid later. Works like a credit card against your equity.
• Fixed-rate HELOC option: Converts a portion of a HELOC balance to a fixed rate and amortization schedule — rules vary by lender.
• Cash-out refinance: Replace your existing mortgage with a larger mortgage and take the difference in cash.

Uses for borrowed equity

• Eliminate private mortgage insurance (PMI) once equity reaches the lender’s threshold (often 20%; some lenders cancel automatically at 22%).
• Consolidate high-interest debt (credit cards, personal loans) into lower-rate home-secured debt.
• Fund major expenses (home improvements, education, large purchases) at typically lower interest rates than unsecured borrowing.

How to increase home equity

• Make a larger down payment at purchase to start with more equity.
• Choose a mortgage that reduces principal steadily (avoid interest-only loans if building equity is a priority).
• Make every mortgage payment; pay extra principal when possible.
• Stay in the home to capture appreciation.
• Make value-adding home improvements (research which projects typically boost resale value).

Pros and cons of borrowing against equity

Pros
– Lower interest rates compared with unsecured loans and credit cards.
– Potential tax-deductible interest if funds are used for qualified home improvements (consult a tax professional).
– Easier approval in some cases because the loan is secured by the property.

Cons
– Adds debt and monthly payment obligations, reducing cash flow.
– Risk of foreclosure if you default, since the loan is secured by your home.
– Fees and closing costs can increase total borrowing cost.
– Some equity products may restrict how funds are used.

Quick FAQs

• Is home equity taxable? No — loans secured by equity are debt, not income. However, consult tax rules for specific deductions.
• How much equity can I borrow? Lenders typically limit total loan-to-value (TLTV), often up to 80–90% combined loan-to-value depending on product and borrower qualifications.
• Is home equity liquid? No — converting equity to cash requires a loan (HELOC, home equity loan, or refinance) or selling the home.

Bottom line

Home equity is a significant household asset that can be leveraged for lower-cost borrowing or to build long-term wealth. Use equity responsibly: consider the purpose of borrowing, compare products and rates, account for fees, and understand the risks of securing additional debt with your home.