How to Use Home Equity: What It Is and How It Operates

Oct 17 | 8 minutes read
How to Use Home Equity: What It Is and How It Operates

Home equity is the amount a homeowner has invested financially in their home. In other words, it is the actual property's market worth as of the present day, minus any liens that may be associated with it.

As mortgage payments increase and market factors affect the property's current value, the amount of equity in a home changes over time.

Home equity can refer to more than just a mortgage loan that has been repaid. Homeowners can borrow money against this asset to cover crucial expenses like paying off high-interest debt or covering college costs.

Due to the fact that borrowing against home equity is secured by equity, interest rates are often lower than those for credit cards and personal loans. So your home's equity could be a wise source of money. Additionally, interest paid on such borrowing is typically tax deductible if the money is put toward home improvements.

Equity is the amount you owe on your mortgage minus the value of your home today. You have $50,000 of equity in your home if you owe $150,000 on your mortgage loan and it is worth $200,000 in home.


The Basics of Home Equity

If you use a mortgage loan to pay for all or a portion of a home, the lending company will have ownership rights to the home up until the loan is repaid. Home equity is the share of a home's current value that the owner currently owns.

When you make a down payment to purchase a home, you first build up equity in the home. As mortgage payments are made after then, a homeowner's equity keeps increasing. This is because a particular portion of each payment is designated to lower the remaining principal balance that you still owe.

The value increase of your house is another factor that increases equity.


How to Calculate Your Home Equity

 Equity is the amount that is due on a mortgage loan compared to the value of the home.

Get a rough idea of the value of your home by looking at recent sales of properties similar to yours in the area before calculating your home equity. Let's say it is $350,000. Additionally, ask your lender for the amount representing the remaining balance on your loan. Let's say once more that it is $150,000. Given those numbers, the calculation is as follows:

Home value minus loan debt equals equity.

$350,000 minus $150,000 is equity.

$20000 is the equity.

Calculate Your Home Equity


Building Home Equity

Fortunately, there are several strategies to increase your home's equity.


  • Put A Big Down Payment On It

Making a sizable down payment is the quickest way to develop equity. The more equity you have in your home right away depends on the size of your down payment.

Let's say you spend $180,000 on your home. If you put $5,000 down, your mortgage balance will be $175,000 after that. You are now left with $5,000 in equity. On a home worth $180,000 with a $20,000 down payment, you will owe $160,000. It's much more amazing to have $20,000 in equity than $5,000.

Understanding how you'll create equity in your home begins with determining how much you can put toward your down payment. Before making an offer, getting preapproved for a mortgage will help you determine how much of your money will go toward the down payment.


  • Pay attention to paying off your mortgage

Every mortgage payment you make will be applied at home to the loan's principal. The remainder will often be used to pay interest, real estate taxes, and homeowner's insurance.

Less of your initial mortgage payment will be used to principal reduction and more will be applied to interest when you first start making payments. The good news is that more money will be allocated to lowering your main balance and increasing your equity the longer you keep your mortgage.

However, it's crucial to be aware that not all loans function in this way.

You won't lower your principal debt or increase your equity if you take out an interest-only mortgage or another type of non-amortizing loan. Your contributions will only be used to cover your interest, insurance, and property taxes. You'll eventually have to make a one-time payment to settle the main balance of your loan.


  • Don't Just Pay the Minimum

You can always pay more than the minimum payment due each month if you wish to increase your equity faster. You can reduce your loan's principal balance and help homeowners build up their home equity more quickly by making extra payments every year, whether on your own, through biweekly payments, or even by paying an extra $100 each month.


  • Remain in your home five years or longer

If the value of your home rises, you'll accrue equity. No house will necessarily improve in value, but if you live in your home for a longer period of time, your chances will be better.

If you want to see your home's worth increase by enough to increase your equity, you should plan on staying there for at least five years.


  • Renovate and enhance the exterior

By constructing an additional bedroom, remodeling the outdated kitchen, or adding a master bathroom, you can increase the value of your house. Adding landscaping and improving the curb appeal of your home might also be beneficial.


Using Home Equity to Borrow

Home equity can take time to grow, unlike some investments. Because your property's current market value was used to determine the equity computation, that is the case. The home might not actually sell for that much, even though the appraisal suggests it might.

However, an owner can use the equity in their home as collateral in a number of ways to access low-cost cash for their financial requirements. Some of them are listed here.


Mortgage Loan

You can typically borrow a lump sum against the equity of your present home with a home equity loan, also known as a second mortgage, at a fixed rate for a predetermined length of time. To pay for significant expenses like home repairs or college tuition, many homeowners use home equity loans.

Mortgage Loan


Home equity line of credit

A home equity line of credit (HELOC) is a type of revolving credit that allows you to borrow up to a specific amount over a specific amount of time and typically has an adjustable interest rate. With a HELOC, you can constantly borrow up to the permitted amount while making payments on the debt, just like a credit card.


Line of Credit with a Fixed Rate for Home Equity

The term "fixed-rate HELOC" refers to a borrower's arrangement to convert some or all of the funds secured by a HELOC to a fixed rate. Then, after a predetermined amount of time, the borrower will repay the fixed-rate sum. Because lenders may have varying guidelines regarding how you might use this option, be careful to conduct your due diligence.


Refinance with Cash-Out

Using your equity to obtain a new mortgage that is more expensive than the balance on your current mortgage is known as a cash-out refinance. After that, you spend the remaining funds as needed and pay off the current mortgage. The money is tax-free because the IRS views it as debt, not income, similar to how it views home equity loans and lines of credit. You are free to utilize the funds however you like.


Use of Home Equity

The amount of equity in your home and the money you borrow against it can be put to use in ways that will help your finances.

When you have 20% equity, you should cancel your private mortgage insurance. Usually, when your equity exceeds 22%, PMI is immediately terminated. You can ask to have it removed, though, for 20%.

Pay down any outstanding balances on high-interest credit cards. Home equity loans typically have substantially lower interest rates.

Avoid higher-cost debt by using funds from your home equity instead of credit cards or loans to pay your payments or make necessary expenditures. Instead of getting a student loan, for instance, use the money to pay for college tuition and other costs. You can make the necessary home improvements without getting a higher-interest personal loan.


Tips for Increasing Home Equity

Once you are aware of the advantages of home equity, you might wish to concentrate on increasing it. Put as much money down as you can on the home you're buying to start building equity right away. 

Know what kind of mortgage you are obtaining. For instance, stay away from interest-only loans if you want to steadily increase your equity. Payments for that are just applied to the interest. Up until a single lump sum is needed, no principal is paid off.

Make all required mortgage payments on time, and aim to pay more than the bare minimum.

Stay put to benefit from any rise in the value of your home. You're more likely to experience some appreciation the longer you're in it. It increases your equity share.

Think about investing in home upgrades that will increase its worth. Do your homework before making any renovations because not all of them will increase the property's value.


Pros Cons
Obtain the necessary funds and swap out more expensive payment methods Possibly put owner under further debt and associated expenses
If money is utilized for capital upgrades, interest is tax deductible Having to limit how you spend money
lower interest rates compared to credit cards and unsecured loans There may be fees that increase the actual pricing.
The money you borrow is tax-free



Final Verdict

Home equity is the portion of a home's value that the owner owns as opposed to the portion that is owned by the mortgage loan's lender. It includes any down payments made, the amount of monthly mortgage payments applied to principal reduction, and any increase in the home's value.

Beyond being able to get rid of the loan you took out to acquire your home, having equity gives you the ability to borrow money.

Owners who require funds for their financial demands might obtain a home equity loan or a home equity line of credit. A cash-out refinance is another option they have. Generally speaking, borrowing fees for home equity are lower than those for credit cards or personal loans.

Additionally, since they are borrowed funds rather than earned income, the money you get from a home equity loan, home equity line of credit, or cash-out refinance is tax-free.

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