What Is Home Equity?
Home equity is the difference between how much you owe on your mortgage and how much your home is worth—that is, how much of the home you own. The more equity you have, the more of the home you own and the greater your stake in the property as an asset.
There are 3 ways to accumulate home equity: 1) through your down payment; 2) by paying down your mortgage; and 3) through appreciation of your home’s value. Most homeowners will benefit from all 3. Here’s an example:
- You buy a home worth $400,000; financing $320,000 with a down payment of $80,000. From Day 1, you start with $80,000 in home equity.
- Over 5 years, you pay $29,000 toward the mortgage. You now owe $291,000. By paying down your loan, you raise your equity to $109,000.
- During this time, the value of your home has also increased to $415,000. This appreciation further increases your home equity to $124,000.
In an ideal situation, the equity in your home will go up every year. However, during periods of economic recession, your home may lose value—meaning your equity will also decline. Even if your home equity does go down, property is a stable, appreciable asset, so it’s likely to go back up.
How Can You Use Home Equity?
Once you’ve gained equity in your home, you can use it. Some people use their home’s equity toward a larger down payment on their next home. Others use it as collateral (i.e., property you pledge as a guarantee to repay debt) to take out either a home equity loan (HEL) or home equity line of credit (HELOC).1 You may sometimes hear HELs and HELOCs referred to as second mortgages. Homeowners often use home equity loans and lines of credit to pay for college, home renovations, medical expenses, new vehicles, a second home or credit card, and other debt.
Before you decide to take out a home equity loan or line of credit, it’s important to understand that you’re borrowing against your home. By doing this, your home debt grows, and if you’re unable to make your loan payments, you could end up losing your home.
Comparing Loans and Lines of Credit
While both HELs and HELOCs rely on the equity in your home, there are some key differences between the two that can help you identify which option is best for your needs.
|Key Differences||Home Equity Loan (HEL)||Home Equity Line of Credit (HELOC)|
|Overview||Provides a one-time lump sum with a fixed interest rate. You’ll pay this loan back with a monthly payment that is separate from your mortgage payment. If your lender offers them, interest-only home equity loans can lower your monthly payments for a set period of time (around 5 or 6 years). After that, you’ll pay both the principal (or initial) amount and interest.||Allows you to borrow what you need, when you need it, via a revolving line of credit. The amount available to borrowers depends on the amount of equity they currently have. If your lender offers an interest-only option, these can keep your monthly payments low for up to 20 years. Keep in mind that most HELOCs also have a small annual charge to keep the line of credit available, even if you’re not using it.|
|Loan Payout||Lump sum||Revolving credit|
|Loan Amount||Often up to 100% of home’s value||Often up to 95% of home’s value|
|Term||5 to 30 years||Up to 20 years|
|Deductible interest2||Up to $100,000||Up to $100,000|
With a cash-out refinance, you take out a new mortgage to pay off your existing mortgage. In addition, you take out extra cash in a lump sum that you can use toward a house renovation, college education or other expenses. Essentially, you’ll close on a new mortgage with different terms. Your new loan may have a lower interest rate or give you more time to pay off the loan. You’ll receive a lump sum when you close on the refinance.
How to Maximize Home Equity
Making the most of your home equity means looking at both sides: building it and using it.
To build strong equity, continue to make on-time payments and pay extra toward your mortgage whenever you can. Invest in your home with home improvement projects that raise its value. You may think of your home as simply where you live, but it is also an asset: something you can invest in.
When it comes to using home equity, be smart about how you’re tapping into it. Determine if a HEL, HELOC or cash-out refinance is the best way to access that money. Also, make sure you have a plan to use your equity in a healthy way and pay back your loan in a timely manner.
Talk with Navy Federal Credit Union about how to harness the power of home equity to accomplish everything you want to do in your life. Whether it’s applying for a home equity loan or just learning how much equity you have, Navy Federal is here for you.
Some lenders may not use these industry terms for closed-end (HEL) and open-end (HELOC) equity loans. Navy Federal uses Fixed-Rate Equity Loan (FEL) to refer to a fixed-rate home equity loan that is disbursed in its entirety at closing. A Home Equity Loan (HEL) refers to Navy Federal’s equity line of credit product.↵
Consult with your tax advisor.↵
This content is intended to provide general information and shouldn't be considered legal, tax or financial advice. It's always a good idea to consult a tax or financial advisor for specific information on how certain laws apply to your situation and about your individual financial situation.