Definition
Equity is the ownership value a homeowner has in a property, calculated as the difference between the property’s market value and the amount still owed on the mortgage. As homeowners pay down their mortgage or as the property’s value increases, their equity grows.
Explanation
Equity is one of the biggest advantages of homeownership, as it represents real financial value that can be accessed or leveraged in various ways. There are two primary ways equity increases:
- Paying Down the Mortgage – Every mortgage payment made reduces the loan balance, increasing equity.
- Property Appreciation – If a home’s value rises due to market conditions, renovations, or neighborhood improvements, the homeowner’s equity also increases.
Homeowners can leverage their equity in several ways:
- Cash-Out Refinance – Replaces the existing mortgage with a larger loan, allowing the homeowner to withdraw a portion of their equity as cash.
- Home Equity Loan (Second Mortgage) – A lump-sum loan based on the home’s equity, usually with fixed interest rates.
- Home Equity Line of Credit (HELOC) – A revolving credit line that allows homeowners to borrow against their equity as needed.
- Selling the Home – If a homeowner sells, their equity is the amount left over after the mortgage and selling costs are paid.
However, equity can also decrease if home values drop or if homeowners take on additional loans against the property.
Example
A homeowner buys a house for $400,000 with a $50,000 down payment and takes out a $350,000 mortgage. Over time, they pay down the mortgage to $300,000, and the home’s market value rises to $500,000.
Their equity calculation would be:
Equity=HomeValue−MortgageBalanceEquity
Equity=500,000−300,000=200,000
The homeowner now has $200,000 in home equity, which they could use for refinancing, a home equity loan, or selling for a profit.