An Example
You may own a home, but do you own it free and clear? Most people borrow money to buy a home. Assume you bought a home for $200,000, made a 20% down payment, and you got a loan to cover the rest.
In that example, your home equity interest is 20% of the home’s value. The home is worth $200,000 and you contributed $40,000 - or 20%. You own the home, but you really only "own" $40,000 worth of it.
It might be best to think about home equity in terms of what you owe instead of what you’ve contributed. Prices change over time. You can figure out how much home equity you have by subtracting any money you owe from the home’s value. The home is worth $200,000, but you owe $160,000. The loan balance is 80% of your home’s value, so the remaining 20% is your home equity.
Now assume your home’s value doubles (unlikely, but it’ll keep the numbers simple). If it’s worth $400,000 and you still owe $160,000, you have a 60% equity stake. Your loan balance hasn’t changed, but your home equity increased.
Building Home Equity
As you repay your home loan, your home equity generally increases. With each monthly payment, you pay a little bit of interest and you reduce your loan balance. Over time, more and more goes towards your loan balance - increasing your home equity interest.
- See how it works by calculating loan components
What is Home Equity Used For?
Equity is an asset, so it’s a part of your total net worth. You can spend it someday if you need to. You might use it to buy your next home, to live in retirement, or to pay for an education. It’s a large and important asset, so choose wisely.
When you get a second mortgage, you borrow against your home’s equity. It’s nice to have a large pool of money to draw from, but home equity loans can be dangerous. Your home serves as collateral for these loans. If you can’t repay them, you may lose your home.
