What is home equity?

Owning a home is already an accomplishment. But being a homeowner could also unlock another financial perk: the equity you've built. 

What is home equity? Your home equity is the difference between your home's value and what you owe on your mortgage. 

If you've been working hard to pay down your mortgage and your home's value has increased, it may be possible to borrow against your equity. And if you're exploring ways to resolve debt, the equity you've built could help. Let's review some strategies for how to use home equity. 

How home equity works

When you talk about home equity, you’re talking about how much of the property you own. Home equity builds over time as the difference between the home's value and the mortgage balance widens. 

The first way to build equity is by making a down payment when buying a home. The more you put down, the less you need to borrow. You could start building equity with a down payment. 

Once you become a homeowner, equity could continue to build thanks to: 

• Decreasing mortgage debt

• Increasing home value

As you make payments on your mortgage and the loan balance decreases, your equity grows. Your equity also grows when your home's value rises.

Tip: It's possible to have negative equity, meaning your mortgage debt is greater than your home's value. You might hear people call this being upside down or underwater on a mortgage. Many homeowners experienced this during the 2008-2009 financial crisis, when home values plummeted. It's not common historically, but it could happen.

How to calculate your home equity

How do you calculate home equity? You can calculate how much equity you have by subtracting your remaining mortgage balance from your current home value. 

Here’s the formula: 

Current home value − remaining mortgage balance = home equity

Here’s an example: 

Imagine you owe $268,000 on your mortgage and your home is worth $320,000. 

$320,000 − $268,000 = $52,000  

Why home equity matters

Having equity in your home could be a benefit in a few ways.  

Build wealth 

Home equity is a long-term strategy for building wealth. As you pay down your mortgage, you gradually convert your debt into assets. This wealth could give you greater financial flexibility. 

Improved financial security 

A financial emergency can happen when you least expect it. Your home equity could provide added financial security, as a ready resource in case you need it.

Benefit when you sell your home 

If you decide to sell your home, your equity could help you cover the down payment for your next house. Using the wealth you’ve built could help you reduce the amount you need to borrow and make monthly payments more affordable on your next mortgage. 

Access to funds when you need to borrow money 

Home equity could provide access to money when you need it. You could borrow against your home equity using a home equity loan or HELOC. 

Compared to unsecured loans, like personal loans, home equity loans typically have lower interest rates. A lower rate could save you money on interest fees.  

Here are some reasons you may want to borrow against your home equity: 

• Debt consolidation. If you have high-interest credit card debt or other debts, a home equity loan could help you pay them off. Consolidating debts with a home equity loan could leave you with fewer monthly debt payments and potentially save you money on interest. 

• Home renovations. Want to upgrade your kitchen? Time for a new roof? You could use a home equity loan to pay for home renovations or repairs. Some renovation projects could help you boost your home's value, increasing your home equity. 

• Major purchases. A home equity loan could help you cover large expenses. Your equity could help cover college tuition for a career change, or pay for medical expenses not covered by insurance. 

How to build home equity

Here are some ways to increase home equity: 

• Pay down your mortgage. As you make regular payments on your mortgage, the remaining balance will decrease, which builds equity as long as your home's value stays the same or increases. Every little bit helps.

• Make principal-only mortgage payments. Making additional payments toward the principal of the loan could help you build equity faster. If you have at least 20% equity in your home and are paying private mortgage insurance (PMI), you can likely ask your lender to remove PMI so you put that money toward extra principal-only payments. 

• Increase home value. Investing in home improvements could add value to your home, which can build equity. Big projects like kitchen and bathroom remodels could add significant value to a home. Even improving your curb appeal with landscaping could help.  

Common myths about home equity

Let’s debunk some misconceptions about home equity.

Home value equals home equity

Just because your home is valued at $275,000 doesn’t mean that you have $275,000 in equity. To calculate how much equity you have, subtract your remaining mortgage balance from your home's appraised value. Be sure to include all mortgage debt, including any second mortgage or home equity loans.

You can get a HELOC or home equity loan with only 15% to 20% equity 

You'll need sufficient equity in your home to qualify for a home equity loan or HELOC. Most lenders require homeowners to have at least 20% equity, but you'll likely need more than that to borrow against it. 

Indeed, lenders generally prefer that you maintain at least 15% to 20% equity in your home after your home equity loan or HELOC. 

To determine eligibility and borrowing limits, lenders calculate your combined loan-to-value (CLTV) ratio. CLTV compares the total debt you owe on your home (your primary mortgage and other secured loans, including any you’re applying for) to the home’s value. 

Most lenders have a maximum CLTV of 80%. That means you probably won't be able to borrow more than 80% of your home value, minus what you owe on your mortgage and any other loans secured by your property. This means you’ll likely need more than 15% to 20% home equity to qualify for a home equity loan or HELOC. 

It takes years to build home equity

While it can take time to build home equity, it doesn't always take years to do so. You could start with home equity simply by buying the house for less than its worth or by making a large down payment. 

You could also boost home equity by making additional payments toward the principal of your mortgage. Another potential way to increase home equity is by making improvements to your home. You may also build equity passively; when the real estate market does well, your home value could increase, which can boost equity. 

What's next

• Figure out how much equity you have in your home to see what you might be able to borrow with a home equity loan or HELOC.

• Check your credit. Secured loans, like home equity loans, tend to have more flexible credit requirements than other types of credit, but your credit could still come into play.

• Review your budget. A home equity loan or HELOC is secured by your home, so make sure you can comfortably manage any payments so you don't put your home at risk.