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What Is Home Equity?

Home equity is one of your most valuable financial assets, if you know how to tap into it.

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Owning a home offers you more than just a place to live and make memories. It also allows you to build equity

Home equity is the difference between what you owe on your mortgage and the current value of your home. Equity is valuable because it allows you to borrow money against your home at lower interest rates than other types of financing. You build equity by consistently making mortgage payments over the years. But it’s also affected by shifts in the housing market. 

Most homeowners now have more equity in their homes than they did two years ago, thanks to surging home values during the pandemic. Now might be the right time to consider tapping into your home equity.  

Here’s what you need to know about home equity, including what it is, how to calculate it and the different ways to leverage it.

How home equity works 

Once you have enough equity built up in your home, lenders and banks will allow you to borrow against it. Some of the more common reasons to borrow against your equity include home improvements and to pay for life expenses such as education costs or debt consolidation.

In simple terms, you’ll take how much your home is currently worth and subtract what you owe on your mortgage to determine how much equity you’ve built. You may need to work with an appraiser or real estate agent in order to get an accurate evaluation of your home’s appraised value. 

Most US lenders want to see that you’ve built up at least 15% to 20% equity before approving you for any type of home equity financing. One of the simplest ways to ensure you have a good chunk of equity in your home is to make a large down payment if you’re able to. For a typical homeowner with a 30-year fixed-rate mortgage, building up 15% to 20% equity usually takes about five to 10 years.

How do you calculate home equity?

There are a few important steps to take when trying to calculate your home equity. Even if you paid less for your home when you bought it years ago, the way home equity works is that your equity is based on the present-day value of your house, and most lenders will require an up-to-date home appraisal conducted by a professional to accurately determine your home’s current appraised value. 

Once you have a current appraisal, look up your outstanding mortgage balance and subtract it from the appraised value. If, for example, your home is currently worth $500,000 and you have $400,000 left to pay on your mortgage, then you have $100,000 of equity in your home. 

$500,000 – $400,000 = $100,000

The next step is to determine your loan-to-value ratio, or LTV ratio, which is your outstanding mortgage balance divided by your home’s current value (your combined loan-to-value ratio, or CLTV ratio, is simply the ratio of all outstanding loans secured against your property divided by your home’s current value. Most lenders want to see a CLTV of 85% or lower). So for a $500,000 home, the calculation would be: 

$400,000 / $500,000 = 0.80

That formula means you have an 80% LTV ratio. Most lenders will let you borrow in the neighborhood of 75% to 90% of your available home equity, but having a high LTV tells a lender you may be a risky borrower. To determine if you’ll hit that threshold you can use the below formula, which assumes a lender will allow you to borrow up to 85% of your home equity:

$500,000 [current appraised value] X 0.85 [maximum equity percentage you can borrow] – $400,000 [outstanding mortgage balance] = $25,000 [what the lender will let you borrow]

You can also use a home equity calculator to determine whether you have enough equity available in your home to qualify for a typical home equity loan.

Ways to borrow against home equity 

There are various ways to access the equity in your home. Some of the most common options are home equity loans, home equity lines of credit and reverse mortgages. It’s important to keep in mind that all of these options require you to put up your home as collateral to secure the loan, meaning there is a risk of losing your home to foreclosure if you miss payments or default on the loan for any reason. 

Home equity loan

home equity loan lets you borrow money against the equity you’ve built in your home and provides you with a lump sum of cash at a fixed interest rate. Lenders typically want to see that you have at least 15% to 20% in your home to approve you for a home equity loan. A home equity loan doesn’t replace your mortgage like a refinance, rather, it’s an entirely new loan that you’ll repay monthly along with your existing mortgage payment. But just like a mortgage, with a home equity loan, your interest rate never changes and your monthly payments are fixed, too.

HELOC

home equity line of credit, or HELOC, is a type of loan that lets you borrow against the equity you’ve built up in your home and functions like a credit card. It provides you with an open line of credit that you can access for a certain amount of time, typically 10 years, followed by a set repayment period, which is usually 20 years. Lenders also generally want you to have at least 15% to 20% in your home for HELOC approval. With a HELOC, you don’t have to take all of your funds out at once, and you can withdraw money repeatedly from your HELOC over the 10-year period, once previously borrowed sums are paid back.

“A HELOC offers more flexibility than a home equity loan -- you can’t withdraw money from a home equity loan like you can with a HELOC, and a HELOC allows you to receive replenished funds as you pay your outstanding balance,” says Robert Heck, VP of Mortgage at Morty, an online mortgage marketplace.

HELOCs have variable interest rates however, so it’s important to make sure you can afford higher monthly payments if your rate goes up once your introductory interest rate expires, especially in the current economic climate. 

Reverse mortgage  

You must be 62 years or older to access a reverse mortgage and have either paid off your home or have significant equity accumulated, usually at least 50%. With a reverse mortgage, you do not have to make monthly mortgage payments and the bank or lender actually makes payments to you. You must still pay your property taxes and homeowners insurance and continue to live in the house, however. A reverse mortgage allows you to access the equity in your home and not pay back the funds for an extended period of time while using them for other expenses during retirement.

It’s important to keep in mind that you are building a mortgage balance back up as you borrow against your equity, and your estate will eventually have to pay off your loan. A common way to repay this loan is to sell your house.

Fixed-rate line of credit

A fixed-rate line of credit is essentially a hybrid of a HELOC and a home equity loan. This type of home loan works like a regular HELOC, but the difference is that unlike a standard HELOC -- which has a variable interest rate that rises and falls with economic conditions -- you will pay the same fixed-interest rate on the principal balance and every single draw, no matter the amount or when you withdraw your funds, which could be advantageous in today’s rising interest rate environment. 

Some banks and lenders may let you refinance a HELOC into a fixed-rate HELOC or a home equity loan depending on the specific options available to you and your personal financial situation.

Cash-out refinance

Similar to a home equity loan, a cash-out refinance provides you with a lump sum of cash at a fixed-interest, but it replaces your current mortgage with an entirely new mortgage that has more attractive terms, mainly a lower interest rate. The lump sum you borrow against your home equity is added back on the balance of your mortgage and you pay it off as one monthly payment. However, with mortgage rates at 14-year highs, it’s unlikely that a cash-out refi will make sense for most homeowners in today’s rising interest rate environment.

The bottom line

Put simply, home equity is the current price of your home minus all outstanding debts on it, but there’s more to it than that. When applying for home equity financing, the appraised value and the loan-to-value ratio of your house will affect the size of loan you’re eligible for. When comparing different types of home loans, it’s important to also consider the interest rate, as well as any costs and fees associated with the loan, to ensure you can comfortably afford to pay it off.

Alix is a former CNET Money staff writer. She also previously reported on retirement and investing for Money.com and was a staff writer at Time magazine. Her work has also appeared in various publications, such as Fortune, InStyle and Travel + Leisure, and she also worked in social media and digital production at NBC Nightly News with Lester Holt and NY1. She graduated from the Craig Newmark Graduate School of Journalism at CUNY and Villanova University. When not checking Twitter, Alix likes to hike, play tennis and watch her neighbors' dogs. Now based out of Los Angeles, Alix doesn't miss the New York City subway one bit.
Katherine Watt is a CNET Money writer focusing on mortgages, home equity and banking. She previously wrote about personal finance for NextAdvisor. Based in New York, Katherine graduated summa cum laude from Colgate University with a bachelor's degree in English literature.