What is Home Equity?
Put simply, home equity is the amount of value you own in your home. You can generally calculate the equity you have in your home by subtracting the balance of your mortgage from your home's appraised value. For example, if your home is appraised at $150,000 and your mortgage balance is $90,000, you have $60,000 in equity.
The equity in your home increases when you pay down your mortgage or when the appraised value of your home increases. Home value increases are usually a result of changes in the market or improvements made to the property.
How Can I Use My Equity?
Because home equity is something you own, it can be used as collateral. The most common types of loans that accept home equity as collateral are Home Equity Loans or Home Equity Lines of Credit (HELOC); these loans are sometimes called a "second mortgage".
Home Equity Loan vs HELOC
Home Equity Loans and HELOCs are two loans that allow homeowners to tap into the equity of their houses. Understanding the difference in these loans can help you make sure you're choosing the best loan type for your needs.
Home Equity Loan
Home Equity Loans are funded in a single lump sum. Home Equity Loans are good for large, one-time expenses like roof repairs, major car repairs, and debt consolidation. If your month-to-month income varies, a Home Equity Loan may be a good choice for you because it offers stable interest rates with predictable payments.
HELOCs are an excellent option if you're seeking borrowing flexibility. With a HELOC, you are approved for a maximum line of credit based on your home equity. You can withdraw from that line of credit anytime during the "draw period". Draw periods typically range from 5 to 10 years, and you'll make interest-only payments on just the amount you've withdrawn, not the entire line of credit. After the draw period, you'll enter the "repayment period". In the repayment period, you can no longer make withdrawals from the line of credit. The repayment period generally ranges from 10 to 20 years, and you'll make payments on both the principal (amount borrowed) and interest during this time.
HELOCs are generally useful for expenses that are less predictable or are large, recurring sums, like medical bills and tuition. Because most HELOCs are variable rate, your payment amounts might not be consistent from one period to the next, making it important to consider your comfort with fluctuating payments before applying for a HELOC.
New to adjustable-rate mortgage products? The Consumer Financial Protection Bureau's "Consumer Handbook on Adjustable-Rate Mortgages" can help you understand how adjustable-rate mortgages work.