What is home equity?

If you’re thinking about borrowing against your home, it’s important to understand what home equity is and how much equity you have.

Home equity is the market value of your home minus the amount you owe on your mortgage. In other words, it’s the portion of your home’s value that you don’t have to pay back to a mortgage lender. Building your home equity can help you increase your net worth, and you may be able to use your home equity as collateral for a loan or credit line.

There are some steps you can take to grow your home equity, and it can rise over time if the value of your property goes up. Whether you should borrow against your equity depends on your financial goals, but we’ll review some of your options.

• How do I calculate my home equity?
• How do you build equity in your home?
• Should I take equity out of my house?
• How to borrow against home equity
• How to use home equity
• Home equity FAQs

How do I calculate my home equity?

To figure out how much home equity you have, first find the appraised market value of your home. This is what your home would probably be worth if you decided to sell it.

Next, look up the remaining balance on your mortgage. If you have more than one mortgage on the property, look up that balance, too. Add the balances from your mortgages together to find the total amount you owe on your home.

Take your home’s value and subtract the total amount you owe. The result is the value of your home equity.

Here are some examples of how to calculate your home equity.

How do you build equity in your home?

You build equity in your home when you reduce the amount you owe on your mortgage, and assuming your home generally holds (if not increases) its value. You also build equity simply when your house becomes more valuable.

When you make your mortgage payments on schedule, you may build equity over time. Making some extra payments or paying more than the amount required each month can allow you to build equity faster.

If you’re buying a home, one way to ensure you have more equity from the start is to make a large down payment. And if your down payment is at least 20%, you usually aren’t required to buy private mortgage insurance. That means you have a lower monthly payment, and you can use the money that would otherwise go to insurance to pay off more of your principal and build equity faster.

You also gain equity when the value of your home goes up. This can happen over time because of changes in the supply and demand for homes in your area — although it’s also possible for your home’s value to fall instead.

You may be able to raise your home’s value and build equity by making home improvements. But before having any work done on your home, it’s a good idea to do some research to find out how much your home’s value is likely to increase as a result of the upgrade and whether the increase in equity will make up for the cost of the work.

Should I take equity out of my house?

Whether you should take equity out of your house depends on your goals. Using your house as collateral may allow you to borrow enough to cover major expenses like college tuition, high-interest credit card debt or a home improvement project. And the interest rate is likely to be lower than on an unsecured personal loan, so this can be a more affordable way to borrow for a large purchase.

On the other hand, if you aren’t able to pay back the principal and interest, the lender could take ownership of your home. And you’ll probably have to pay fees. So you may not want to borrow against home equity if you don’t have a significant reason to.

When you’re deciding whether to borrow, it’s helpful to get an estimate of your monthly payment and the total amount you’ll pay in principal versus interest.

You can use Credit Karma’s loan amortization calculator to explore how different loan terms affect your payments and the amount you’ll owe in interest.

How to borrow against home equity

If you choose to use home equity to borrow, you may have several options.

Home equity loan

A home equity loan is a loan in which the lender gives you a lump sum upfront, and you agree to pay it back within a certain period of time. Your home equity is the collateral.

Depending on how much equity you’ve established in your home, a home equity loan can give you access to a large amount of cash if you need to finance a big purchase. And home equity loans usually have fixed interest rates, so payments are predictable.

You’ll likely pay fees to take out a home equity loan, though. And if you aren’t able to make the monthly payments, you could lose your house.

Keep in mind that your loan amount will likely be limited to borrow up to 85% of your home’s equity.

HELOC

A home equity line of credit, or HELOC, is a credit line that lets you borrow against your home equity. You can borrow up to your approved credit limit, pay the money back and borrow again, as long as you’re still in the draw period — or a set number of years when you can borrow through the HELOC.

When the draw period is over, you may have to pay the money back right away, or you may be able to repay it within a predetermined repayment period. You may also have the option to renew the HELOC.

A HELOC gives you the flexibility to borrow multiple times, which can be convenient if you need to pay for recurring expenses or a variety of needs. And because the credit line is secured by your home, you’ll likely have a lower interest rate than on other forms of revolving credit like credit cards.

Interest rates on HELOCs are usually variable interest rates, so your borrowing costs could rise over time. You typically pay fees to set up a HELOC, and you may also owe annual fees and fees for each time you borrow more money.

Cash-out refinance

Refinancing means taking out a new loan to repay your current mortgage or mortgages. In cash-out refinancing, you get a new, larger mortgage that covers what you owe on your existing mortgage and that uses some of your home equity to give you a cash payment.

If you choose a new mortgage that has a lower interest rate than your previous mortgage, you could save on interest. You also might be able to refinance with different terms, such as more time to repay the loan (or less) and a new monthly payment.

Potential downsides of refinancing are that you may not be able to find a mortgage with better terms than your existing mortgage. You’ll also have to pay closing costs to the lender. And because you are borrowing a larger amount to turn some equity into cash, it may be harder to repay the loan, so make sure to calculate your new payments into your monthly budget.

Reverse mortgages

With a reverse mortgage, you give a lender part of the equity in your home; in exchange, the lender gives you monthly cash payments. You must be age 62 or older to take out a reverse mortgage, and your home must be in good condition.

A reverse mortgage can give you money for living expenses while allowing you to continue living in your home. You typically don’t have to pay back the loan as long as you live in your home, and you generally don’t have to pay taxes on the cash you receive.

But you will probably pay fees and interest. Interest rates on reverse mortgages are usually variable, so your rate could go up. If you move out of your home to live in a long-term care facility or stay with family, you’ll probably be required to pay back the loan, which might mean you’d have to sell your house.

Also, your heirs wouldn’t be able to inherit your house if you sold it to repay a reverse mortgage.

How to use home equity

Home equity can be used for a variety of different purposes, but you want to consider how to tap it carefully. When you use your home as collateral for a loan or line of credit, you risk losing your home if you’re unable to make the payments as agreed.

Plus, you may have to pay closing costs for a HELOC or home equity loan, so you’ll want to factor these costs into your decision.

Here are four ways to consider using your home equity.

1. Removing PMI

PMI is a type of mortgage insurance you’re typically required to take out if you have a conventional loan and your down payment is less than 20%.

Once you reach enough equity in your home, you can contact your lender and request to have them cancel the PMI. The lender must cancel your PMI once you’ve paid down the mortgage to at least 78% of the original value of your home.

2. Consolidate debt

You can also use your home equity to pay off debt. For instance, you may be able to use the funds to pay down high-interest credit card debt, repay medical debt or pay off your student loans.

Using your home equity to pay off debt can make sense if it helps you streamline your payments or save money on interest. But it’s a good idea to talk to a financial planner first to make sure this option makes financial sense.

3. Making home improvements

You may also tap into your home equity to complete home improvement projects, such as a kitchen or bathroom renovation or replacing your roof.

Keep in mind that it’s rare for home projects to totally recoup the amount of money you spend on them in added value.  

Learn more about how to increase your home’s value.

4. Paying for other large expenses

If you want to pay for a major expense, such as a child’s school tuition or large purchase, using your home equity may make sense. You’ll want to calculate the cost of the interest you’ll pay on your purchase first to ensure it’s the best option for you.

Next steps

Before deciding to borrow against home equity, compare your options to find the best deal for your situation. If you’re concerned about possible home foreclosure, you might be better off using a credit card or taking out an unsecured personal loan that doesn’t put your home at risk.

Watch out for scammers promising spectacular results if you tap into home equity. Claims that you’re guaranteed to make money by investing the proceeds of a home equity loan, that you can wipe out your debt by borrowing only a fraction of what you owe, or that you’ll receive extravagant freebies like a new house are signs that an offer is not legitimate.

Home equity FAQs