Equity
Equity is the difference between a property's current market value and the total amount owed on all mortgages and liens against it. Equity increases as the borrower makes mortgage payments, the property appreciates in value, or both. It represents the owner's financial stake in the property.
What This Means
How Equity Builds
Homeowners build equity through two primary mechanisms. First, each mortgage payment reduces the outstanding principal balance through amortization, gradually increasing the owner's share. Second, property appreciation driven by market conditions, neighborhood improvements, or home upgrades raises the home's value relative to the debt. In a declining market, equity can decrease or become negative (often called being "underwater"), where the mortgage balance exceeds the property's value.
Equity and Loan-to-Value
Equity is inversely related to the loan-to-value (LTV) ratio. A homeowner with 30% equity has an LTV of 70%. Reaching equity on a conventional mortgage allows the borrower to request cancellation of private mortgage insurance (PMI). Under the Homeowners Protection Act, servicers must automatically cancel PMI when the LTV reaches of the original purchase price, based on the amortization schedule.
Accessing Home Equity
Once sufficient equity has been established, homeowners have several options to access it:
- Home equity loan: a fixed-rate, lump-sum second mortgage
- HELOC: a revolving line of credit secured by the home
- Cash-out refinance: replaces the existing mortgage with a larger loan, providing the difference in cash
- Reverse mortgage (HECM): available to homeowners age and older, converts equity into payments without requiring monthly repayment
Most lenders require borrowers to retain at least equity after any equity withdrawal, meaning not all accumulated equity is accessible.