What Is Home Equity?
Home equity is the value of a homeowner’s interest in their home. In other words, it is the real property’s current market value less any liens that are attached to that property. The amount of equity in a house or its value fluctuates over time as payments are made on the mortgage and market forces play on the current value of that property.
- Home equity is the value of the homeowner’s interest in their home.
- An owner can leverage their home equity in the form of collateral to secure either a home equity loan, a traditional home equity line of credit (HELOC), or a fixed-rate HELOC.
- A large down payment on a home (over 20%) will immediately provide a homeowner with more equity in their home than a smaller down payment.
How Home Equity Works
If a portion—or all—of a home, is purchased by means of a mortgage, the lending institution has an interest in the home until the loan obligation has been met. Home equity is the portion of a home’s current value that the owner actually possesses free and clear.
Equity in a house can be acquired via the down payment you make during the initial purchase of the property and with your mortgage payments, since a contracted portion of that payment will be assigned to bring down the outstanding principal you still owe. You can also benefit from property value appreciation as it will cause your equity value to increase.
Home equity is an asset and is considered a portion of net worth, but it is not a liquid asset.
Ways to Leverage Home Equity
Unlike other investments, home equity cannot be quickly converted into cash. The equity calculation is based on a current market value appraisal of your property. But that appraisal is no guarantee that the property would sell at that price.
However, an owner can leverage their home equity as collateral to secure either a home equity loan or a home equity line of credit (HELOC), or fixed-rate HELOC, which is a kind of home equity loan and HELOC hybrid.
A home equity loan, sometimes referred to as a second mortgage, usually allows you to borrow a lump sum against your current home equity for a fixed rate over a fixed period of time. Many home equity loans are used to finance large expenditures like home repairs or college tuition.
A home equity line of credit (HELOC) is a revolving line of credit usually with an adjustable interest rate which allows you to borrow up to a certain amount over a period of time. HELOCs work in a manner similar to credit cards, where you can continuously borrow up to an approved limit while paying off the balance.
An Example of Home Equity
If a homeowner purchases a home for $100,000, with a 20% down payment and covers the remaining $80,000 with a mortgage, the owner has equity of $20,000 in the house. If the market value of the house remains constant over the next two years, and $5,000 of mortgage payments are applied to the principal, the owner would possess $25,000 in home equity at the end of the two year period.
If the market value of the home had increased by $100,000 over those two years, and that same $5,000 from mortgage payments were applied to the principal, the owner would then have a home equity of $125,000.