Home Equity Is Soaring — if You're Tempted to Borrow Against Your Home, Read This First

Home equity is on the rise.

According to data from property analytics firm CoreLogic, home equity jumped by 6.6% between the second quarters of this year and last — an overall increase of $620 billion and nearly $10,000 in additional equity per homeowner. In some states (hello, Montana, Idaho and Washington), homeowners gained more than twice that, largely due to a 5% jump in home prices over the same period.

With a recession and global pandemic still in full force, they’re striking numbers. Compared to last year, they’re also a marked improvement. Between the second quarters of 2018 and 2019, homeowners saw their equity rise just 4.8% — or about $4,900 per house. Home equity is also a key difference between the 2008 recession and today.

But what exactly does rising home equity mean for homeowners? And what can you do with it once you have it? Here’s what you need to know.

What is home equity?

Home equity is the share of your home that you actually own — the difference between its market value and the money you owe on your mortgage. As Andrew Weinberg, principal and mortgage loan originator at SilverFin Capital, explains, “It’s the amount you would net if you sold your home and paid off your mortgage.”

To calculate how much equity you have in your home, subtract your loan balance from your home’s total value. Then divide that number by the value. For example, if you had $150,000 remaining on your loan and a home worth $200,000, you’d have 25% equity ($50,000 / $200,000).

You increase your home equity by paying down your mortgage. The more you reduce your loan balance, the more equity you have, and the more you’ll make when it’s time to sell.

Keep in mind that mortgage loans are amortized — meaning your monthly payment goes toward interest first and then toward your principal balance. In the beginning, when your balance is highest, that means monthly payments reduce the loan balance very little, resulting in only a small amount of equity gained in the first few years. If you’re looking to whittle down your balance quickly and increase your equity stake, you’ll want to consider making extra payments toward your principal (tax refunds can help here).

Still, paying down your debt isn’t the only way to build equity. Equity also rises and falls based on the value of your home. If you make certain improvements to the property or home prices rise in your area, so does the home’s value, and that pushes your equity stake up with it.

It’s the latter that’s primarily behind today’s rising equity. “Increasing levels of equity are overwhelmingly a function of rising home prices in recent years,” says Andy Walden, economist and director of market research for data firm Black Knight. “We’ve now seen over eight consecutive years of positive home price growth, with the average home price setting a new record high in each of the past eight months.”

Home equity loans, lines and cash-out refinances

There are some serious benefits that come with increased equity. For one, if you’re currently paying for private mortgage insurance, you may be able to cancel that policy and reduce your monthly payment. On conventional loans, you can request to cancel your insurance once you reach 20% equity. Most lenders also want your to have at least that much equity to refinance.

You can pull out equity as debt using a cash-out refinance, home equity loan or home equity line of credit — which essentially works like a credit card, giving you funds to draw from as needed. “People often do this to fund home improvement projects, consolidate debt or buy a second property,” says Grant Moon, founder of Home Captain, a real estate listing platform.

Meanwhile, equity-sharing startups like Unison, Haus and Hometap allow homeowners to sell off a portion of their equity in exchange for cash. There’s no monthly payment or interest. Instead, the companies take a portion of the sales proceeds once you’re ready to sell the home.

According to Loraine Burger, marketing manager for the company, Hometap is an option for homeowners who want a debt-free way to use their home equity. And because the company has no hard credit score minimums, it can also be helpful for homeowners with not-so-perfect credit. The average customer has a 600 score or higher compared to 752 for a mortgage borrower.

“It offers unique qualification criteria compared to loans, lines of credit and reverse mortgages, so many responsible homeowners who don't qualify for a traditional solution can qualify for it,” Burger says.

Lessons from the housing crisis

Tempting as it is, leveraging your home equity can be risky. For one, it could leave you upside down on your mortgage, owing more on the home than it’s currently worth. This is also called negative equity, and it was a major problem during the last recession.

“Home prices were declining during the 2008 to 2009 recession, and many homeowners saw their equity vanish,” says CoreLogic’s chief economist Frank Nothaft.

In fact, in 2009, a whopping 26% of homeowners had negative equity. This played a prime role in the subsequent wave of foreclosures, which led to nearly 4 million homeowners losing their properties by the end of 2010.

“Before the Great Recession, when home equity borrowing reached an all-time high, consumers began to think of their home’s equity as just one more source of cash,” says John B. Ward, president of First American Bank. “The results, of course, were disastrous for both lenders and borrowers.”

Fortunately, the conditions are less dire in today’s recession. Home prices rose at their fastest rate in two years this July, and negative equity is at a decade low of 3.2%. Though there’s no guaranteeing those trends will continue, it can help homeowners feel more confident when tapping their equity — as long as they know their market.

“In communities that continue to have rising home prices, home equity will likely increase,” Nothaft says. According to his company’s data, the places most at risk for declining prices — and declining home equity — are Las Vegas; Prescott, Arizona; Lake Charles, Louisiana; and Miami.

Still want to take out cash? How to reduce your risk

If you’re thinking about tapping your home equity, there are several ways to reduce your risk. The first is to simply choose the right loan product.

According to Weinberg, that means avoiding a HELOC — or home equity line of credit. These typically come with adjustable rates. Though this results in low monthly payments up front, it can often lead to sticker shock once full payments come due down the line. Another downside? The interest isn’t tax-deductible like on traditional mortgages. (You can only deduct your HELOC’s interest if you spend the funds on home improvements). Additionally, many HELOCs only require interest payments for the first decade or so, meaning you could go years without chipping away at the debt.

“The safest thing that you can do when drawing on your home equity is to get your loan into a 30-year fixed product,” says Weinberg. “Don’t kick the can down the road."

Retaining a solid share of equity in your home can also help reduce your risk, as can having a flush savings account. This ensures you can always make your monthly payments — no matter what’s happening in the housing market.

“Home values rise and fall, so if you find yourself in a negative equity situation, you can ride it out, making your monthly payment until your home’s value rises once again,” Moon says.

The only risk-free option, though? That’s to steer clear of using your equity altogether.

“If you think of your home’s equity as an investment — oftentimes your major one — ideally, you should do nothing with it,” Ward says. “As time goes on, it will grow to become a very substantial part of your net worth.”

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