What is Home Equity?

Home equity equals the value of a house less the balance owed on the homeowner's mortgage.

How to calculate Home Equity

Let's assume that John Doe pays $200,000 for a house. He puts 20% down and makes another $25,000 in principal payments over the next few years. At that point, John Doe's home equity is about $55,000 ($40,000 of down payment plus $25,000 of principal payments).

The amount could be higher if John's house has appreciated. For example, if John has put $55,000 into the house and the house has increased in value by $10,000, then John's home equity is really $65,000.

Why does Home Equity matter?

Home equity is an asset, and some people can borrow against that asset. These loans, called home equity loans, are very similar in concept to traditional mortgages. For example, home equity loans generally must be repaid over a fixed period. Some lenders may offer fixed rates on these loans, others might offer variable rates.

Home equity loans can be viable options when compared to credit cards or other high-interest, unsecured loans. In addition, mortgage interest is tax-deductible, making the interest rates on home equity loans sometimes lower than they appear when one considers the tax savings.

However, not all home equity loans are created equally. Borrowers are well served to compare fees, interest rates and repayment terms among lenders. After all, when a borrower defaults, his or her home could very well end up belonging to the bank for good.