Home Equity: Explained in Six Questions

The complicated stuff in life gets a little less complicated when you break it down into six basic questions: What, Why, Who, Where, When and How?

What is home equity?

Home equity is the portion of a home’s value that you own outright. If you took out a mortgage to pay for your home, your lender owns part of your home until your mortgage is paid off.  Any money you kicked in for a down payment is considered equity.

To determine your home equity, subtract the balance of your mortgage from the current appraised value of your home. 

How can you build and access home equity?

There are two ways this can happen. 

One way is through price appreciation, which could occur when your home increases in value due to either the housing market or home improvements you’ve made.

The other way is by paying your mortgage. As you continue to pay down your mortgage, you increase your equity. 

Why is home equity important?

Home equity is important because of the options it can give homeowners. 

You can take the home equity you’ve accumulated in your current home and put it toward the purchase of your next home. 

You can borrow against the equity in your home with a home equity loan (also called a second mortgage) or home equity line of credit (HELOC). A home equity loan lets you borrow a lump sum at a fixed rate; with a HELOC you receive a credit line that you can draw against within a specified period of time and up to a certain credit limit. HELOCs tend to come with variable interest rates.

Home equity can also be used to refinance your home through what’s known as a cash-out refinance, which is when you replace your mortgage with a new mortgage for more than you currently owe. By doing this, you get the difference in cash and the freedom to spend it as you please – but you’re also taking on more debt due to a higher mortgage.  

This is not an exhaustive list and, of course, each of these options has its own pros and cons, so be sure to consult with a trusted advisor on which is the best option for you. 

Who offers home equity loans and HELOCs?

You can apply through banks, mortgage lenders or credit unions. You do not need to go through your mortgage lender.

Where have been the greatest home equity gains in recent years?

According to a recent report  from Redfin, the top three metro areas with the most total equity growth in dollars since 2012 have been Los Angeles ($15 billion), Seattle ($8 billion) and Oakland ($7.9 billion). Homeowners in Tacoma, Wash. (1453%) and Virginia Beach (1333%) have seen the highest percentage increases in home equity in that same time span.

When should you consider tapping into home equity? 

That all depends on your situation. Aside from using your equity toward the down payment of another house, one reason to take out a home equity loan or HELOC may be for home improvements , which could increase the value of your home. Or you could not touch the equity in your home and instead look for a home improvement loan. Again, you should take careful consideration with any of these options, as there are risks involved.