Are you wondering what is equity in a home — or how to unlock it? Whether you want to renovate or consolidate debt, tapping your home's equity could be the key. In this post, we'll explain home equity basics and strategies for leveraging it to achieve your financial goals.
What is home equity?
Home equity is the portion of your home's value that you own. In other words, it's the difference between your home's current worth and what you owe on the mortgage. As time passes — and mortgage payments are made — your equity grows.
Equity is the value of the home minus any outstanding debts on the loan. For example, if your home's current market value is $180,000 and the mortgage balance is $100,000, you own $80,000 of equity. When the principal balance is zero, you own 100% equity in the home.
Beyond representing how much of the home you own, equity is also a valuable asset for homeowners. Homeowners have a plethora of home equity products to choose from. They can use the equity in their home to meet different financial needs, like repaying taxes and insurance or combining debts.
How to calculate your home equity
Determining home equity is simple:
- Gauge your home's estimated market value: You can use online tools — such as Zillow Zestimates or Redfin — to find estimates. Alternatively, you can work with a licensed real estate agent or appraiser for a more accurate assessment of your home value.
- Subtract debts owed: Subtract any debts associated with the property — such as the mortgage balance and liens — from the market value.
How can you build home equity?
The more home equity a mortgage holder has, the more financial security they have — particularly when it comes time to borrow money or cash in. Therefore, in addition to learning what is equity in a home, it's crucial to know how to increase it.
- Make larger or additional mortgage payments: Paying down your mortgage is one of the most effective ways to increase the amount of equity you own. By making extra payments on the mortgage loan, a higher amount will go to paying off the principal rather than the interest — growing your equity faster.
- Invest in home improvements: In addition to paying down what is owed, increasing the value of your property can help boost equity. For example, projects such as a kitchen remodel or adding an ADU can add significant value. However, before jumping into upgrades, be sure the cost of renovations offsets the added value.
- Wait for home value to rise: Since equity is tied to the appraised value of your home, micro and macro factors can impact it. For example, if your neighborhood is deemed a hot market, you'll likely experience a boost in the value of your home. Similarly, negative changes will also affect equity, such as market crashes and dips. Therefore, it's best to be proactive in growing your equity.
How can you use your home equity?
There are plenty of reasons homeowners choose to access their home equity. Some common motivations include:
- Debt consolidation: Debt consolidation is a smart way to reduce high-interest debt. Home equity loans offer better rates than other consumer loans. Therefore, it is a great option for debt consolidation.
- Home renovations: Home improvements can get costly, but leveraging your equity to cover the expenses can keep interest fees low. Equity can help finance remodels to help homeowners age-in-place or make value-adding improvements.
- Investing in yourself: Small business owners and entrepreneurs can harness their home equity to fund their businesses or subsequent investment pursuit.
- Tuition: Tapping your home wealth can help pay down existing loans or help children with upcoming costs.
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How to access your home equity
Homeowners can borrow against or cash in on their home equity to meet their financial needs or wants.
Home equity loan
Home equity loans allow borrowers to access home equity by securing a second mortgage. Lenders use your home as collateral and give you a lump sum payout in cash — repaid through a new monthly mortgage payment. They hold a fixed interest rate and can have a repayment term of one to thirty years.
Home equity loans can offer a competitive rate compared to other consumer loans. However, other home equity loan alternatives may offer the best rate depending on the market.
Pros:
- Borrowers receive a lump sum of cash
- Predictable monthly payments due to fixed rates
- Lower closing costs compared to a cash-out refinance
Cons
- An additional monthly mortgage payment
- Strict criteria: average loan-to-value (LTV) ratio of 85% or lower, solid credit, and low debt required
- Risk of foreclosure
Home equity line of credit (HELOC)
A home equity line of credit (HELOC) is one of the most widespread ways homeowners access home equity. Similar to a home equity loan, a HELOC gives you access to cash using your home as collateral.
A HELOC offers a predetermined credit limit in place of a lump sum. This credit can be used as needed. As you take money out of the line of credit, you subsequently increase your debt obligation. Once the draw period ends, you no longer have access to the funds, and the repayment period begins — this typically lasts 15-20 years.
Pros:
- Access to funds whenever you need them
- Flexible repayment options based on the terms you decide to go with
- Freedom to use the funds as you want
Cons:
- Have variable interest rates that can fluctuate over time
- May have prepayment penalties
- Risk of foreclosure if debts go unpaid
Home Equity Investment (HEI)
Another homeowner-friendly option to access home equity is a Home Equity Investment (HEI). Homeowners get a lump sum of cash — with no restrictions and no monthly payment — in exchange for a portion of their home's future appreciation. Instead, you repay the amount plus a small percentage of your home's appreciation any time during a 30-year term — through a home sale, refinance, or another source of funds.
Pros:
- Lump sum payout
- No monthly payments
- You can potentially pay back less than what you borrowed
- No restrictions on how you can use your money
- No prepayment penalties
Cons:
- Minimum credit score required — this varies from lender to lender
- Restrictions on the type of properties that qualify
- You must pay back the investment in one lump sum payment
Cash-out refinance
With a cash-out refinance, homeowners replace their existing mortgage with a larger one, receiving the difference in cash. The money is tax-free, and there are no restrictions on how you can use it.
For example, if your home is worth $750,000 and you have $400,000 remaining on the loan, you can generally cash out up to 80% — in this case, $200,00. [80% of $750,000 is $600,000 minus the $400,000 mortgage balance leaves $200,000 in equity]. So your new sample loan amount is $600,000, but you can keep the extra funds without having a second mortgage.
The current average rate for a 30-year fixed refinance loan is 7.10%, and the average for a 15-year fixed-rate refinance is 6.29%.
Pros:
- Homeowners get a fixed rate
- You can receive a lump sum of cash
- Interest rates have the potential to be tax-deductible
- Opportunity for a better rate depending on the market
Cons:
- Monthly payments
- High closing costs — credit check, appraisal, closing fees
- Specific lenders have prepayment penalties
Reverse mortgage
A reverse mortgage is another common financial product used to access home equity. It allows seniors — those 62 years or older — to sell the equity they've built in their home back to a lender. There are various types of reverse mortgages on the market, each with varying terms and methods of payout — it's essential to research this tricky financial product.
Depending on the option, homeowners can get a lump sum of cash at closing, monthly payments for a fixed period, or a line of credit. The debt must be paid when the borrower dies, permanently moves out, or sells the home.
Pros:
- No monthly payments
- Borrowers can choose between a lump sum of cash or a revolving line of credit
- The potential for a tax-deferred lump sum
Cons:
- It could affect other retirement benefits such as Medicaid or Supplemental Security Income (SSI)
- Borrowers have closing costs to cover — insurance and HOA fees, an upfront insurance premium, and origination fees at closing
- You'll have to pay your existing mortgage balance off first
Determining which home equity option is best for you
Now that you can successfully answer 'what is equity in a home,' you might be considering unlocking what you've earned. With so many home equity products to choose from, selecting the best fit for your situation can take time and effort. Start by assessing your current and future finances to determine which solution works best.
Consider these questions as you evaluate your options:
- What is your overall financial situation? Are you overwhelmed by debt? Do you have emergency funds you can access in case of a job loss or other financial setback?
- What types of short-term and long-term savings goals do you have? Are they affected by the amount of home equity you hold?
- How long do you plan to stay in your current home?
Talk to lenders from each loan option to determine what you likely qualify for. Then compare interest rates, repayment terms, and other factors — such as the amount, monthly payments, and closing costs. Do any of these options support the current financial situation and future goals you described above? If yes, you may be on your way to successfully tapping into the equity you’ve earned in your home.
Next steps
With a market full of products aimed at homeowners with growing equity, it’s essential to be particularly discerning when selecting the right one. While traditional lenders offer interest-based products like home equity loans, HELOCs, and refinance cash-outs, there is a growing demand for alternative solutions like Point.
Visit Point to find out if you qualify to fund your goals without new monthly payments.
