Definition: In the context of mortgages, equity represents the portion of a property’s value that the homeowner actually owns, as opposed to what is still owed to the lender. Equity is calculated as the difference between the property’s current market value and the outstanding balance on any mortgage or other liens secured by the property.

How equity works

• Building equity over time: Homeowners increase equity with each mortgage payment made, as a portion goes toward paying down the principal. Equity also grows as the property’s market value appreciates.
• Loan-to-value ratio (LTV): Equity is closely tied to the LTV ratio, where a higher LTV indicates less equity and a lower LTV indicates more. For example, if you’ve paid down 20% of your home’s value, you have 20% equity and an 80% LTV.

Types of equity usage

1. Refinancing: Homeowners can leverage their equity by refinancing, taking advantage of better interest rates, or consolidating debt.
2. Home Equity Line of Credit (HELOC): A revolving line of credit secured against home equity, allowing homeowners to access funds as needed.
3. Second mortgages: Additional loans secured by the home’s equity, useful for renovations, investments, or other large expenses.

Benefits of equity

Building equity provides financial flexibility and security, as it can be accessed for investments, home improvements, or to meet emergency expenses. Significant home equity can also eliminate the need for mortgage insurance if refinancing or securing a new loan.

Last modified: November 5, 2024