Understanding home equity: Everything you need to know

Key insights:

• The average homeowner gained $20,000 in home equity by the end of Q3 2023.
• An increase in home equity could impact your mortgage insurance.
• Home equity can be used to fund a number of life stages — from buying or building a new home to retirement, home improvement projects and beyond.
• Borrowers should understand how their home equity is calculated and what the best options are for tapping into it.

You may have seen the headlines earlier this year: Due to fast-rising home prices, the average homeowner gained more than $20,000 in home equity through the end of Q3 2023. That represents a 6.8% jump in home equity compared to the prior year.

But despite these gains, it’s harder than ever for some homeowners to make ends meet. While everyone’s financial situation is different and we can’t make specific recommendations on whether you should take advantage of your home equity, it’s important that homeowners understand the power and options they have in today’s market environment.

Let’s dive into what home equity is and what choices homeowners with equity can make if desired.

What is home equity?

In the simplest terms, home equity is the difference between what you owe on your mortgage and your home’s current market value. If you owe $100,000 on your mortgage and your home is worth $400,000, then you have 75% home equity. Conversely, if you have a remaining mortgage balance of $300,000 on your $400,000 house, you have 25% home equity.

Your home’s equity rises when:

• You pay off more of your mortgage (and your home value remains steady).
• Market conditions raise your home’s value.

The housing market can be a major contributor to homeowners’ gains in home equity: when home prices go up, so does the amount of equity you have in your home because your home equity is based on how much you owe on your home’s value at the time you bought it and what it’s worth today.

The market value of a house can be impacted by many factors, but it mostly boils down to supply and demand. A rapid jump in home sales creates higher sales prices, leading to higher home values and a home equity increase for homeowners. As was the case during the past few years, the number of homes on the market has dropped and prices have increased due to the competitive market, which has also led to an increase in selling prices and therefore an increase in home equity.

What happens to my mortgage insurance when my equity rises?

Two groups typically pay mortgage insurance to their lender:

• All borrowers with FHA loans
• Conventional loan borrowers who put down less than 20% at closing

Mortgage insurance payments help lenders offset the risk of lending to less-than-perfect loan candidates, but that risk is diminished when the home’s equity begins to rise. Once the borrower’s home equity reaches 20% of the original purchase price, their mortgage insurance may be canceled for the rest of the loan term.

READ: How and when should I cancel my mortgage insurance?

What can I do with my newly accumulated home equity?

There are a multitude of options available for homeowners who want or need to leverage their home’s equity. Below is a list of the most common paths for using or tapping into home equity. Remember, your financial situation is unique and you should speak with your financial advisor and lender to determine your ideal path.*

Sell and pocket a profit

The easiest-to-understand way to benefit from your home’s equity is to sell your home and reap the profits. If you owe just $50,000 on your $450,000 house, for example, then nearly $400,000 in home equity will be yours as you leave the closing table (less your closing and other costs associated with the transaction). Note: This does not account for capital gains taxes, which may or may not apply to your situation.

You can use that net profit to fund your next chapter — whether that be a new property, a retirement community or an RV that will take you across the country in your golden years.

Apply for a reverse mortgage

Homeowners who are 62+ and have most of their wealth tied up in their home may consider a reverse mortgage. In a reverse mortgage, the homeowner stops paying their monthly mortgage payments and their lender gives them a monthly or lump sum based on their home’s equity. As you would expect, this agreement will diminish the homeowner’s equity over time, and increase their debt; the homeowner will then pay off the lender with the profits of their eventual home sale.

Reverse mortgages can be beneficial for homeowners who wish to age in place, but who don’t have the savings or investments to fund their retirement.

Borrowing against your equity

Last, there are three other ways to borrow against your home’s equity. Each of them has different terms and benefits.

• Fixed-rate home equity loan: Homeowners can tap into their home equity to cash out a single lump-sum payment. The loan has a set interest rate and a typical payment term of between 5-15 years.
• Home equity line of credit (HELOC):^†Homeowners can tap their home equity as needed in a revolving line of credit that is akin to a credit card. Borrowers have a “draw” period when they can take out the money, followed by their repayment period. HELOCs usually have variable interest rates that change over time, though some lenders are beginning to offer fixed-rate HELOCs.
• Cash-out refinance:^‡Think of a cash-out refinance as a two-step process. First, borrowers replace their existing mortgage loan with a new loan that exceeds the amount they owe on the home. Next, they receive a lump sum payment that represents the difference between their home’s value and the amount they’ve borrowed.

Whether it’s to consolidate or pay off debt, make home improvements or fund other needs, these options can be a helpful solution for the right borrower.

Need help calculating your home equity?

Big financial decisions should be made carefully, and our experienced team can offer the insights you need to make decisions about your home’s equity. Reach out to Edina Realty or a mortgage consultant for private, professional assistance.

*Prosperity Home Mortgage, LLC, Prosperity Home Mortgage, LLC dba Edina Realty Mortgage, and HomeServices Lending, LLC are not financial advisors and cannot and are not offering financial advice. Please contact your financial advisor to discuss whether a home equity line of credit fits your overall financial goals.

^†Home equity line of credit may not be the right option for all borrowers. Not all borrowers will qualify. Contact your mortgage consultant to discuss each of the financing options available to you. Home equity lines of credit provided by third party. Some and/or all qualifying criteria may be set by an independent third party. Borrowers will be subject to qualification and must satisfy all underwriting requirements and conditions.

^‡By refinancing an existing loan, your total finance charges may be higher over the life of the loan.

Edina Realty Mortgage is an affiliate of Edina Realty. See Affiliated Business Arrangement Disclosure Statement

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