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. In an ideal situation, the equity in your home will go up every year as home values rise and your loan principal decreases with your monthly payments. During periods of economic recession, your home may lose value, meaning your equity will also decline.
Here is an example of how you gain equity in a home:
You make a $20,000 down payment and take out a $180,000 mortgage to purchase a home that has a sale price of $200,000.
In five years, you pay $13,000 toward the mortgage. You now owe $167,000 on the loan.
During this same time, your home value has increased to $230,000.
To calculate your home’s equity, subtract your current loan principal of $167,000 from the home’s current value of $230,000.
You have $63,000 in home equity.
How Can You Use Home Equity?
Once you’ve gained equity in your home, you can use it. Some people will 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 the debt) to take out either a home equity loan (HEL) or home equity line of credit (HELOC).* 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, a new car, or a second home, or to pay off 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.
*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.
Comparing Loans & Lines of Credit
While both loan types rely on the equity in your home to loan you funds, there are some key differences between the two that can help you identify which option is best for your needs.
Home Equity Loan (HEL)
Home Equity Line of Credit (HELOC)
|Provides a one-time lump sum with a fixed interest rate. You’ll pay back this loan 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 principal and interest.||Allows you to borrow what you need, when you need it, via a revolving line of credit. In addition to checks, many financial institutions issue credit cards to make accessing your loan funds easier. If your lender offers an interest-only option, these can keep your monthly payments low for up to 20 years. Beyond that, you’ll pay both principal and interest.|
|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|
|Tax deductible interest*||Yes, up to $100,000||Yes, up to $100,000|
*See your tax advisor.
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.
Section Complete! Here's how you did: