What is home equity and how does it work? 
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September 15, 2022

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Do you want to remodel your bathroom but aren’t quite sure how to pay for it? Are there unexpected home repairs you need to make? 

Using the equity you’ve built up in your home could be just the answer you’ve been looking for. If you’re asking yourself, “what is home equity, and how does it work?” keep reading.

In this article, we’ll dig into what a home equity loan is, the difference between a home equity loan and a line of credit, and how you can use equity to pay for repairs, upgrades, or anything else you consider important. 

What is home equity?

Home equity is the amount of your home’s value you’ve paid off; it’s how much of the home you actually own.

How can I figure out how much equity is in my home?

To figure out how much equity you have in your home, start with the current value of your home and subtract the amount of mortgage principal still outstanding. 

Equity is the difference between your home’s value and the remaining mortgage principal. 

For example, if your home’s value is $250,000 and you still owe $150,000 on your mortgage, your equity is $100,000.

How does home equity work?

Depending on your mortgage terms, you likely paid a down payment somewhere between 3% and 20% when you purchased your home. And that down payment goes toward home equity. 

For example, if you paid a 5% down payment and had a mortgage for the remaining 95% of the purchase price, you’d have 5% home equity, i.e., you own 5% of your home.

How do I build home equity?

Homeowners can increase home equity in one of two ways:

  1. Your home’s equity grows over time as you make mortgage payments—every mortgage payment you make adds to your equity.
  2. The other way your home’s equity can grow is through increased valuation. Home values can increase quickly when housing markets grow, as they did during the last couple of years. 

With an increased home demand during the pandemic’s early days, homeowners saw their homes’ value jump faster than ever before.

When your home value increases, the amount of equity you have in your home automatically increases, even though you haven’t made any additional mortgage payments.

How to use home equity 

Homeowners can withdraw a portion of their home’s equity as cash or a line of credit. 

You can use the money you withdraw from your equity for anything that matters to you. Typical uses of home equity loans or lines of credit include:

  • Big-ticket home improvements or renovations
  • Debt consolidation
  • Covering unexpected expenses—such as medical emergencies
  • Travel
  • Putting toward retirement

Alternately, you can leave your equity in the home. Most homes increase their value over time, so your equity will also increase. 

How do I get the equity out of my home?

You have several options to access the equity in your home, including a lump sum cash loan, a line of credit, or a cash-out refinance.

What’s the difference between a home equity loan and a line of credit

While the phrases “home equity loan” and “home equity line of credit” are sometimes used interchangeably, they are different loan products.

What is a home equity loan?

Home equity loans are lump-sum loans that use the equity in your home as collateral.

Home equity loans offer homeowners with built-up equity access to a large amount of money, typically with lower interest rates than most personal loans. Home equity loans are also often easier to qualify for since the home is used to guarantee the loan. 

Lenders typically consider home equity loans less risky than personal loans, often resulting in better terms for borrowers. 

What is a home equity line of credit?

Like a home equity loan, a home equity line of credit (HELOC) allows homeowners to borrow money using the equity in their home as collateral. But unlike a home equity loan, a line of credit is not a lump sum of cash. 

A HELOC works a lot as a credit card does. 

  • Your HELOC will have a credit limit
  • You can borrow any amount up to that limit
  • You pay interest on the amount you borrow, not on the entire amount 
  • Once the money is repaid, you can borrow up to the same limit again

Some HELOCs offer debit cards that you can use at any ATM.

How to use a home equity loan calculator

If you’re looking at home equity loans or lines of credit, you can estimate your home equity using a mortgage calculator. To calculate how much equity you’ve built up, simply choose the refinance option under loan type. 

Home equity loan requirements

Applying for a home equity loan will be similar to the process of applying for a mortgage. You’ll need to submit documentation that verifies your identity, employment, and income and provide the details about your mortgage.

Because your credit score not only impacts the potential home equity loan rates you might receive but can also make or break your loan application, it’s a good idea to check your credit score before you start. 

The stronger your credit score, the greater your chances of being approved for a home equity loan or line of credit. 

Additional home equity loan requirements include

  • A credit score of 680 or more
  • At least 20% home equity or a maximum loan-to-value (LTV) ratio of 80%
  • A maximum debt-to-income ratio of 43%

A lender will typically also request a home appraisal to help establish your home’s current value. 

How can I apply for a home equity loan?

Now that you understand what home equity is and how you can use it to finance important expenses, AAA Banking can help you move forward.

If you’re ready to apply for a home equity line of credit, start your application online.

Reach out to a licensed loan officer at AAA Banking today if you still have questions about home equity and what kind of rates you could qualify for.

Photo by Tima Miroshnichenko

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