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Buying a home brings with it many confusing terms and processes, like mortgages, interest rates, ARMs and equity. Understanding a home’s equity is one of the most important things a homeowner can accomplish. By knowing your home’s value – and in the process, your home’s equity – you’ll be able to plan ahead for refinancing, fluctuations in the marketplace and, eventually, selling your property.

Equity is the amount of money you have invested in your home in relation to its value. For example, if you owe $100,000 on a home that is worth $150,000, you have $50,000 equity. Lenders pay careful attention to equity: many lenders charge extra fees to borrowers who have less than 20 percent equity in a home. Buyers who have more equity in their homes generally receive preferable interest rates as well because they are considered less of a risk to lenders. Homeowners who pay their mortgages on time gradually increase the equity in their home. If you took out a 30-year mortgage and made every payment for 30 years, you’d end up with 100 percent equity.
Can my home’s equity change?

Yes! In theory, your home’s equity can change daily and without any consequence of your actions. Your equity is based on both your mortgage balance – what you owe on the property – and the market value of the home – what it’s worth if you sold it today.

For example: Your home cost $150,000 when you purchased it, and you now owe just $100,000. But your neighborhood’s real estate market has gone up, and a home next-door which is just like yours sold for $175,000. So, without spending a dime, you gained $25,000 in equity when your neighbor’s home sold.

Of course, equity also works in the reverse. If your local real estate market falls, your equity will fall as well. This is one of the reasons it’s extremely important for homeowners to invest as much in their home’s down payment as possible: You don’t want to owe more than your home is worth.
My home just went up in value. Is that money mine?

Not exactly. The changes in home value – which can be caused by recent sales, the number of properties available and even the latest mortgage rates – affect your equity, but not your checkbook balance. Homeowners can take out a home equity line of credit (or HELOC) or a home equity loan, which are financial tools that lend against the equity you’ve built up.

Different banks and lenders set limits on how much equity you can borrow from your home. Generally, owners use equity loans for home repairs and other large expenses. One of the benefits of equity loans is that the borrowed money is tax-deductible, just like your mortgage.

But remember: Your home is not a piggy bank. Many homeowners borrow too much money out of their equity, and end up with little to no money when they sell their homes. Equity lines are effective financial tools for responsible homeowners. Be sure to seek the counsel of a professional before considering taking out an equity loan.