Home Equity: What It Is, How To Use It, and How To Access It

How to Build Equity in Your Home

Increasing your home equity increases your net worth. If you have more equity in your home, you’ll make more profit when you sell your home or have the ability to borrow money secured by your home possibly at a lower rate when compared to personal loans.

You can build home equity in a few key ways, including:

• Make a large down payment: As mentioned, when you buy a home, your down payment gives you instant equity. The larger your down payment, the more of your home value you own debt-free and the less the lender has a legal interest in.
• Make mortgage payments: As your loan’s principal balance declines, the lender has less legal interest in your home, and you gain that home value as an asset of your financial portfolio.
• Home appreciation: You build equity when your home value goes up due to changes in market conditions. If your house is worth more than you paid for it, that appreciation increases your equity.
• Make home improvements: Both cosmetic and structural improvements typically increase your home's value, and when you increase your home’s value, you increase the amount of equity available from your home.

How to Calculate Home Equity

Fortunately, calculating home equity is fairly easy. Here’s how you can estimate out how much home equity you have:

1. Determine your home’s current market value: Your home’s value can be calculated through an appraisal, a comparative market analysis (CMA) from a real estate agent, or through online tools (which may be less accurate than the first two options). A home appraisal will provide the most accurate valuation, but you’ll have to pay an appraisal fee for this service.
2. Find your current mortgage balance: You can find out how much you owe by looking at monthly mortgage statements or contacting your home loan lender. You can also find this information on your credit report.
3. Subtract your loan balance from your home's value: Take the current market value of your house and subtract your current mortgage balance.
4. Subtract other loans or liens that use your home as collateral: If you have a second mortgage or other loans guaranteed by a lien on your house, you’ll need to subtract that amount from the market value.

The table below illustrates how to estimate home equity.

Some portion of this home equity is usually considered accessible, meaning you can use it for other purposes.

What Is Accessible Equity?

"Accessible equity” is a phrase real estate professionals use to describe the amount of money you might be able to access (or borrow) from your home’s equity.

Most of the time, you can’t borrow the full amount of your equity. Instead, you can only "tap" or access a portion of its value because most loan options require you to maintain 20% equity in your home (the exception is VA loans).

One way to calculate accessible equity is by determining the total amount you can borrow based on the lender's allowable loan-to-value ratio (LTV). The more of your mortgage you have paid off, the more equity you can access.

Here’s an example of an accessible equity calculation:

How to Use Your Home Equity

One way you can access home equity is by selling your home. You’ll walk away with the equity left after paying the remaining mortgage, selling costs, and fees. However, there are other ways you can benefit from your equity without selling, including taking out a home equity loan, a home equity line of credit, or a cash out refinance.

Below are a few ways that you might benefit financially from your home equity.

Remove PMI and Save Money

If you’re paying private mortgage insurance (PMI), it’s important to keep an eye on your current home equity.

Conventional mortgages require you to pay PMI if you have less than 20% equity in your home. Once you reach this amount, you can request that your lender remove PMI from your mortgage. This reduces your monthly payment and saves you money immediately.

Your lender is required to remove PMI once your loan balance drops to 78% of your home's value. However, you can and should request that it be removed once you’re at 80% loan-to-value ratio (including appreciation), so you can remove that expense from your monthly payment.

Pay for Large Expenses

Your growing home equity can also be a low-cost source of cash for big expenses. For example, you can borrow against the value of your equity to finance home improvements, pay for college or vocational training, or cover the costs of medical treatments.

If you take equity out of your home to do these things, be aware that you’re increasing your home’s debt. If you can’t afford to make monthly payments, your lender could be forced to foreclose on the property. You typically don’t want to tap equity to cover a big expense unless it’s for an important purchase and you’re confident you can repay it.

Consolidate Debt

When you access your home equity, these loans typically have a much lower interest rate than the rate on other unsecured debts, such as credit cards. This means that if you use your home equity to pay off higher-interest debt, you can save money by paying it down at a significantly lower interest rate.

You can also pay down multiple debts and have a single monthly payment instead of many. Having just one payment simplifies the repayment process and can reduce the chance you’ll miss a payment. Assuming your equity loan has a lower interest rate than the debts you’re consolidating, you’ll benefit from more affordable monthly payments. This is not without its risks, so you’ll want to speak to a financial professional to decide whether this is the best option for you.

Refinance Your Mortgage

Finally, your home’s equity can help you refinance your mortgage to a lower rate. That’s because the value of your equity affects your loan-to-value ratio (LTV). Having a significant amount of home equity lowers your LTV ratio, and lenders can typically offer customers with lower LTVs the most competitive refinancing rates.

Ways To Access Your Home Equity

There are several ways to access your home equity, each with different structures, benefits, and considerations depending on your financial goals.

• HELOC: A home equity line of credit (HELOC) is a revolving line of credit secured by your home. You can borrow as needed up to a set limit during the draw period, typically with a variable or fixed interest rate. Traditional HELOCs require only interest to be paid during the draw period but some HELOCs like the one Freedom Mortgage offers, requires payments on both principal and interest from the start.
• Rate-and-term refinance: A rate-and-term refinance keeps your loan balance the same but simply allows you to save money with a lower interest rate or repay your loan faster with a shorter term. By refinancing, the total finance charges may be higher over the life of the loan.
• Cash out refinance: You can also do a cash out refinance, which replaces your current mortgage with a new, larger loan and gives you a portion of your home equity in cash at closing. The amount of home equity you have affects the amount of money you might be able to borrow. Cash out refinancing allows you to borrow against your equity at competitive interest rates.
• Home equity loan: A home equity loan lets you borrow a lump sum against your equity with a fixed interest rate and a set repayment schedule. It’s often used for large, one-time expenses since payments are predictable over the life of the loan.

Is Using Home Equity a Good Idea?

You need to know if using your equity makes financial sense, and to do that, you need to understand the advantages and disadvantages of borrowing against your home equity. Here are a few pros and cons of using home equity.

Final Thoughts: What Can You Do With Your Home Equity?

Ultimately, many factors affect whether you can access your home equity and whether you should. Home equity can be a valuable financial tool, whether you’re building long-term wealth or exploring ways to save money when you fund major expenses. Understanding how it grows and how to use it responsibly can help you make more informed decisions as a homeowner.

If you’re considering tapping into your home equity, get started today with Freedom Mortgage to see your personalized loan options.