Key takeaway

Home equity refers to the difference between the market value of your home and what you owe on your mortgage. If you have equity in your home, you may be able to set up a home equity line of credit, which is a set amount of money based on that equity that a bank agrees to lend you once approved. You can use a home equity line of credit for repairs or updates to your home or other purchases or expenses. Your home equity loan or line of credit will need to be paid back in addition to the mortgage payment you already have.

You may have heard the term “home equity” mentioned when you were house shopping and putting together your down payment. That’s because once you become a homeowner, equity can play an important role in your future financial picture.

What does home equity mean?

Home equity refers to the current market value of your home, minus what you owe. Say your home is worth $175,000, and you have an outstanding mortgage principal balance of $125,000. In this case, your equity in your home would be $50,000 ($175,000 – $125,000 = $50,000).

How do I get home equity?

The equity in your home changes often. It might go up gradually when you make monthly mortgage payments and pay down the principal loan amount. (You can speed this process by paying a little extra — either each month or just occasionally — to pay down more of the principal loan amount.) Your home equity can also go up if your home’s market value increases, either through improvements you make to your home or through rising local real estate values. For example, if you purchase a $200,000 home, and real estate prices increase in your area in the following years, your home’s value — and your equity — will likely increase as well. But your home equity can also decrease if real estate prices in your area fall.

What can I do with home equity?

You can use your home’s equity as a source for funds, either through a home equity loan or a home equity line of credit (HELOC). Your home equity loan or line of credit will need to be paid back in addition to the mortgage payment you already have. The funds can be used to make repairs or updates to your home, although you can also tap home equity to help pay off debt or fund other goals. Like a mortgage, a home equity loan or a HELOC gives the bank the right to foreclose on your house if you do not repay the loan according to the terms required. So think carefully about whether you can pay back the amount you want to borrow.

A home equity loan is exactly what it sounds like: You borrow a specific amount of money at a fixed interest rate against the equity in your home. Then you make monthly payments over a set period (up to 30 years) to repay the loan. Home equity loans often have lower interest rates than personal loans do.

A home equity line of credit (HELOC) doesn’t give you a lump sum. Instead, it creates a line of credit with a specific total limit and a specific date range for borrowing. A HELOC lets you borrow as you need to, either with special checks or a card; the total you have to pay back either increases as you spend from the line of credit or goes down as you make payments. A HELOC doesn’t last forever. The terms include a draw period, meaning a date range during which you can borrow. When the draw period ends, you have to pay off the HELOC by the lender’s deadline. A HELOC often has a lower interest rate than a credit card. The interest rate may be either variable or fixed.

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