Home Equity: What It Is & How It Works

Home equity is a valuable financial tool that can empower homeowners to achieve their life goals.

What is Home Equity and How Does It Work?

Home equity is a valuable financial tool that can empower homeowners to consolidate household debt, build long-term wealth, and achieve their life goals. If you own your home, you may be able to leverage your home equity, which is essentially the value you own in your home, to access funds as needed. When you’re ready to sell, your home equity could result in substantial profit, which you could use to buy your next home or finance your retirement.  

Home equity is a simple concept, but it can get complicated by factors like market conditions and loan options. So, if you’re confused about what home equity is and how it works, don’t worry. This guide to home equity will explain everything you need to know, including:

  • How home equity works
  • How home equity is calculated
  • Ways you can build home equity
  • Ways you can tap into home equity
  • Ways you can use your home equity

Home equity is the value you own in your home. 

If you paid cash for your home or your mortgage has been paid in full, you own 100% of the value of your home. This means you have 100% equity. 

If you have a mortgage or any other financial liens against your home, your equity is the current value of the home minus the balance of the debt(s) owed on the home.

Another way to think of home equity is that it’s the equity you could potentially make if you sold your home today, ignoring any closing costs.

Home equity can be expressed as a dollar amount or a percentage. For example, the owner of a $500,000 home with a $50,000 mortgage could say, “I have $450,000 in home equity” or “I have 90% equity”.

When you purchase a home, the down payment establishes your home equity. For example, if you make a 3% down payment, your home equity is 3% of the property’s value. 

Home equity fluctuates over time due to changes in the market value of the home and the mortgage payments you make. When your home value increases, your home equity increases. And, when you make a mortgage payment, the equity can increase because the debt is decreasing. On the other hand, if your home value decreases (perhaps because of declining market conditions or deferred maintenance), you could potentially lose equity. 

Knowing how much equity you have is important because it helps you understand how much you can potentially convert into cash if you choose to. In many cases, homeowners can borrow against their home equity, essentially taking out a loan based on the financial strength of their equity.

There are multiple ways to tap into home equity.

How Can Home Equity Work for Me?

Homeowners leverage their home equity for a wide range of uses, including:

Home Improvements or Repairs

This may be an option for homeowners who have been in the home for many years, so they have built up a lot of equity, and the house is due for an update.

Debt Consolidation

Loans against your home equity may offer a lower interest rate than liabilities like credit card debt. By paying off your higher-interest debts with a lower-interest home loan, you could potentially pay less in interest expenses.

Education

If student loans aren’t an option (or if the student still needs more money for school after student loan options are maxed out), homeowners may choose to use their home equity to help.

Purchasing a Second Home

You can use your home’s equity to finance a down payment for a vacation home, second home, or investment property.

Please Note: When establishing a Line of Credit, homeowners should consider how and when the funds will be needed. If you close the account within the first 36 months after opening, then you will be responsible to pay 100% of reimbursable fees back to PNC.[1]

How is Home Equity Calculated?

The formula for calculating home equity is as follows:

Home equity = the current value of the home subtracted by the total debt owed on the home

To convert this to a percentage, use this formula:

Home equity percentage = the dollar value of the equity divided by the market value of the home

Used in an Example

The current value of a home is $450,000, and the owner’s current mortgage balance is $215,000. 

To calculate home equity, subtract the $215,000 debt from the $450,000 value. The resulting $235,000 is the home equity.

Then, if you want to convert the home equity to a percentage, simply divide the $235,000 home equity by the $450,000 market value. The resulting .5222 means the homeowner’s equity is 52.22%.

How Can I Build Equity in My Home?

There are three ways to increase your home equity[2]

1. Market Appreciation

As market conditions cause home values to grow over time, home equity increases.

2. Forced Appreciation

When you make home improvements, for example, a kitchen or a bathroom renovation, you add value to your home, which could increase your home equity.

3. Paying Down Mortgage Debt

When you pay down your remaining mortgage balance, the equity in your home increases by the amount paid toward the principal portion of the loan.

Once My Home Equity is Built, How Can I Tap Into It?

There are three primary methods of accessing your home equity:

Home equity loans are a one-time lump-sum borrowed against your home equity.[3] These loans are then repaid in installments, according to the terms of the loan documents.

The home equity loan application process is similar to applying for a mortgage. You’ll complete an application form and provide proof of income to confirm that you have enough coming in to comfortably repay the loan.

As part of the application review process, your lender may ask to check your credit report. The lender might also require a new appraisal for the property to confirm its current market value.

If your application is approved, the lender notifies you of the approval and drafts loan documents for your signature. These documents outline the loan amount and repayment terms.

Because your home is the collateral for the loan, making on-time payments is crucial. Failing to repay a home equity loan could potentially result in foreclosure in the same way that failing to repay a mortgage could. For this reason, home equity loans are sometimes called second mortgages.

HELOCs are similar to home equity loans, but instead of taking one lump sum, you can open a revolving credit line, which allows you to borrow as needed over a period of time (called the “draw period”).[3] This is similar to the way credit cards work. You are given a credit limit, and you can borrow as much or as little of that amount as you need while the credit line is open. Then you repay the amount borrowed in installments over the repayment period.

HELOCs are often a favorable alternative to credit cards because HELOCs typically offer lower interest rates and higher limits than credit cards. HELOCs are able to offer better terms because, like home equity loans, the borrower’s home is used as collateral for the loan. Securing the loan to real estate makes the loan safer for the lender, allowing them to offer these lower rates and higher line of credit limits.[2]

Understanding how to use a HELOC can help you decide if a HELOC is a better fit for your situation than a home equity loan. If, for example, you’re planning to renovate an older home, a HELOC may be a more attractive option because it allows you to borrow more if unexpected expenses come up. 

Unlike home equity loans, which are typically fixed-rate, HELOCs usually come with an adjustable interest rate, meaning that the interest rate can rise and fall with the market.[3] However, if you prefer the flexibility of a HELOC with the stability of a fixed interest rate, you might consider PNC Bank’s Choice Home Equity Line of Credit, which allows you to lock in a fixed rate part of the line of credit.   

This detailed article on HELOCs vs. Home Equity Loans could help you decide which option is a better fit for you. You can also contact a home equity lending specialist directly for personalized guidance. 

A cash-out refinance takes a different approach to accessing home equity. Rather than taking out a new loan or line of credit, independent from any existing mortgage, cash-out refinancing replaces your existing mortgage with a new mortgage.[4]

Here is an example to help explain the concept of cash-out refinancing:

The owner of a $600,000 home has a mortgage of $200,000. This means they have $400,000 in home equity. They want to use $100,000 of their equity to help finance their children’s college education, and they decide a cash-out refi is the right option for them. 

In this case, their existing $200,000 mortgage is paid off with the funds received from a brand new $300,000 mortgage loan. And the owner gets to pocket the $100,000 difference.   

Importantly, refinancing means that the terms of your original loan no longer apply. So, if you locked in an exceptionally low interest rate on your original loan, you might not want to refinance at today’s rates. On the other hand, if your original loan has a higher interest rate than today’s going rates, you might be able to save some money on interest expenses over the term of your loan. Cash-out refinances may have significant fees as well.

If you think a cash-out refinance may suit you better than a home equity loan or HELOC, you can learn more about the mortgage refinance process and start a refinance application online. 

If you would like to discuss your options with a professional, you can always contact a lending specialist in your area.

Home Equity FAQs

Whether you decide to use a home equity loan, HELOC, or cash-out refinancing, you need to qualify to borrow from your home equity. 

The qualification criteria are similar to those required for a mortgage loan. The following factors are commonly considered when determining eligibility for an equity-based loan:

  • The credit scores of borrowers. Higher scores generally improve your chances of qualifying.
  • The borrowers’ income, as compared to their debts. This is commonly called a debt-to-income ratio. The less of your income that is allocated to debt payments, the better.
  • Mortgage payment history. Late payments or missed payments on your existing mortgage could hurt your chances of qualifying.
  • The amount of equity you have in the home. Lenders typically require that homeowners maintain at least 15-20% equity in the home.[5] So, if you purchased your home with a low down payment and you have less than 15% equity in the home, you might not qualify for an equity-based loan at this point.  
  • How much you want to borrow. Qualifying for a lower amount may be easier than qualifying for a large sum. 

This home equity application checklist outlines the information and documentation you may be asked to provide

Pros of Borrowing Against Equity

  • Leveraging your home equity may give you a financial advantage. For example, home renovations could increase your home’s value, education could increase your earning potential, and sound investments could increase your net worth.
  • Equity-based loans give you the option to pay off high-interest debts (for example, a typical credit card or personal loan) with a lower-interest loan.
  • Because equity-based loans offer lower interest rates by being secured to the property, you could pay less in interest expense by taking a HELOC or home equity loan rather than using an unsecured loan like a personal loan or credit card.
  • You might even be able to deduct the interest from your income taxes if the money is used for "capital improvements" (permanent structural changes that increase the value of your property). Consult your tax advisor for more personalized guidance.    

Cons of Borrowing Against Equity

  • Any loan or utilized line of credit increases the amount of debt you're carrying, adding to the amount you will eventually need to repay.
  • There may be additional fees for originating and/or servicing the loan or line of credit.
  • Because HELOCs make additional funds easily accessible, borrowers need to exercise self-control to avoid overspending.
  • Having a loan secured to your home means that defaulting on the loan could potentially result in foreclosure.

Equity in a home means that the value of the home is worth more than the homeowner owes on the home. Many homeowners think of equity as it pertains to selling.

If you sold your home today and paid off all debts associated with the home, what would your net profit be (ignoring closing costs)? That’s your home equity.

It is possible to have negative home equity, but this is not the norm. Negative home equity means that the owner owes more on the home than the property is worth.

Because most homebuyers are required to invest somewhere between 3% and 20% as a down payment, most homeowners have positive equity from the beginning. The most common scenario in which negative equity occurs is when buyers make extremely low down payments (such as 0%-down VA or USDA loans, for example) and local home values suddenly, sharply decline.[2]

These conditions were present during the housing market collapse of 2008. But with the recent home value growth, it is far more common today for homeowners to enjoy substantial home equity.[7]

Homeowners need to qualify to borrow against their home equity. Qualification is based on a number of factors, including income, credit history, mortgage payment history, and the amount of equity in the home

Take Your Next Steps

Visit Our Home Equity Landing Page

Check current rates, view PNC's Choice HELOC features, and access additional resources.

Visit Our Lending Portal

Interested in other PNC Lending Options? Our Lending Portal is here to help you find the solution that meets your needs.

Learn More About Home Equity

Resources to Help You Understand Home Equity

HELOC vs. Home Equity Loan

Home equity lines of credit (HELOCs) and home equity loans are similar in that they both offer ways to turn your home equity into cash. But these two financial tools are not the same.

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Is a HELOC a Good Idea Right Now?

Is a HELOC a good idea for you? Weigh the benefits of easy access to equity against the risks with our comprehensive guide.

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How to Leverage the Equity in Your Home

Owned your home awhile? If you have significant equity in your home, you possess a versatile financial tool. PNC Bank’s professionals walk through the options for putting your home’s equity to work.

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