Home Equity: What It Is and How You Can Use It

Today, homeowners are sitting on more wealth than they realize. And it’s not in their bank accounts; it’s in their home equity. If you’re a homeowner, it’s a good idea to know what home equity is and how you can use it to your benefit. You might have come across home equity products, such as a home equity loan, home equity investment, or a home equity line of credit. 

All of these products help homeowners tap into their home equity and use it as a financial tool.  However, there are benefits and drawbacks to using the equity you have in your home, and it’s good to be aware of both. This article will explain what home equity is, how you can use it, and the pros and cons of doing so.

Table of Contents

1. What is home equity?
2. How does home equity work?
3. How to use equity in your home
   1. Home equity loans
   2. Home equity line of credit
   3. Home equity sharing agreement
   4. Cash out refinance
   5. Reverse mortgage
4. Resources

What is home equity?

Your home equity is the part of your house that you actually own. It’s the value of your house today minus what you still owe on your mortgage. As home prices rise, homeowners gain more equity. Similarly, as you pay down your mortgage, you increase the equity you have, too. 

What’s interesting about home equity is that it shows that you have a large asset on paper, but it’s not like you can go to the mall and buy something using your home equity. Rather, to use your home equity as a wealth-building tool, you can leverage it to take out loans or use it as collateral to purchase other assets.

There are certain financial products that allow you to tap into your home equity, with the most popular ones being a home equity loan or a home equity line of credit (HELOC). As of December 2024, there is $512 billion in outstanding home equity loans in America, according to the Federal Reserve Bank of St. Louis.

How does home equity work?

It’s really simple to learn how to calculate home equity. There is no calculus required! All you need to know is the current value of your home (which you can get using a tool like Zillow or consulting a local real estate agent) and your current mortgage balance (which you can find by logging into your bank).

Take the value of your home and subtract the mortgage you have left to pay. That’s your home equity. To give an example, let’s say your home is worth $400,000 and you owe $250,000 on your mortgage. When you subtract your mortgage balance from what your home is worth, it shows you have $150,000 of home equity. 

If you want to know the percent of your house you own outright, divide your home equity ($150,000) by your home’s value ($400,000) and multiply the answer by 100 to get a percentage. In this case, the homeowner owns 37.5% of their home. Most lenders want you to have at least 20% equity as one of the qualifications to get a home equity loan or HELOC.

I recommend using your home equity for items that will add long term value to your financial situation. Since you are using your own appreciating asset to purchase something else, you are essentially borrowing from yourself. You want that “something else” to grow or help increase your financial position. Examples include:

• Home improvements. Reinvesting in your home by doing kitchen and bathroom remodels, new roofs, or garage door replacements can boost resale value. You should consult your tax advisor, but interest may be tax-deductible if the funds are used specifically to “buy, build, or substantially improve” the home, which is an additional benefit.
• High-interest debt consolidation, which may save thousands in interest and simplify payments.
• Funding higher education for yourself or a dependent can be an investment in future earning potential.
• Using equity for a down payment on a rental or vacation property can create new income streams and build long-term wealth.

How to use equity in your home

There are many different ways to tap into your home equity. Each of the financial products below has pros, cons, and risks homeowners should be aware of. Homeowners can use the funds from these home equity products to pay off debt, start a business, make home repairs, or invest in another property. Here is more information about the most popular equity products.

Home equity loans

As mentioned, home equity loans are one of the most popular ways to borrow money using your home’s Equity as collateral. The benefit of a home equity loan is that it has a fixed interest rate and equal monthly payments. That means it’s straightforward to budget. The downside is that if you’re not able to make your payments, your lender can foreclose on your home.

Here are a few of our top home equity loan recommendations below.

Home equity line of credit

Home equity lines of credit also use your home as collateral, but they function more like a credit card. There’s an initial draw period where you make interest-only payments. The interest rates are variable, and you can borrow a little or a lot up to your limit. This is helpful if you’re using it for a project, like a home renovation, and are not sure how much funding you’ll need.

The downside is that your payments may be unpredictable depending on how much you borrow. Like a home equity loan, A lender can foreclose on your home if you stop making payments. Also, the interest-only payments don’t last forever. Once the draw period ends, you’ll start paying down your principal over a 10 to 20-year term.

Here are a few of our top HELOC lender recommendations below.

Home equity sharing agreement

A home equity sharing agreement is also called a home equity investment or home equity agreement. This is when you sell a portion of your home’s future value. It’s similar to an investor purchasing a stake in a business and earning money when the business sells. Except, in this case, a home equity Investment Company purchases the percentage of your home’s equity.

With this option, you do not have to make monthly payments, and the home equity company earns money when you buy back your equity,  refinance your home, or sell it. 

Here are our top recommendations for home equity agreements.

Cash out refinance

A cash-out refinance is when you replace your current mortgage with a brand new mortgage for the value that your home is currently worth. Then, you take out the difference in cash. Usually, this is a good move only if you can get a lower interest rate than your current one.

The downside is that, because you are getting a new mortgage, you are essentially resetting your loan, so your 15 or 30-year loan period starts again. Additionally, as with securing your first mortgage, a cash-out refinance usually comes with fees and closing costs. So, it’s important to run the numbers before choosing this option.

Reverse mortgage

A reverse mortgage is a product designed for homeowners aged 62 and older. With a reverse mortgage, homeowners can withdraw the equity they have in their home as cash without having to make monthly payments. The lender makes their money back when the home sells, or when the buyer moves out permanently due to health reasons or passes away.

The downside to a reverse mortgage is that it’s a complex product with high fees. Additionally, it comes with very specific rules that homeowners must follow to keep the reverse mortgage active. Additionally, getting one also reduces the amount of inheritance the homeowners can pass along to their heirs.

Here are some examples of when to “avoid” using home equity. 

• Vehicles: While monthly payments might be lower than a standard auto loan, home equity loans often have much longer terms, meaning you could still be paying for a car long after its value has plummeted. 
• Everyday living expenses: Using equity to cover monthly bills may create challenges and often indicates you are living beyond your means. This can quickly snowball into unmanageable debt. 
• High-risk investments: Borrowing against your home to play the stock market or fund a speculative business/investment ideas is a major gamble that puts your primary residence at unnecessary risk.

Avoid using your home equity in those scenarios that do not add long-term value to your financial situation.

Resources

If you want to learn more about home equity, how it works, and the pros and cons of using it, here are a few resources you can use to learn more:

• Learn how to build equity in a home.
• Watch our videos: What is a Home Equity Agreement? and How to Get a HELOC
• Review our lists of top home equity loans, top HELOCs, and best HEAs.

Some of the bigger mistakes I see made when borrowing from home equity include:

• Overlooking closing costs, annual fees, and early termination penalties.
• Not having a clear plan to repay the principal, especially when interest-only draw periods end.
• Treating your home equity like a “piggy bank” for non-essential items and overspending.