How home equity works: building it, borrowing it, and protecting it

What is home equity, and how do you figure it out?

Home equity is the part of your home you own outright. To find it, take your home's value today and subtract every loan secured by the home. That means your first mortgage plus any second loan or credit line.

Here is the math. Say your Las Vegas home is worth $450,000. You owe $270,000 on your mortgage. Your equity is $180,000. As a share of the value, that is 40%.

Lenders look at the same numbers from the other side. They call it loan-to-value, or LTV. It is your loan balance divided by the home's value. In the example, $270,000 divided by $450,000 is 60% LTV. When there is more than one loan on the home, they add the balances together. That is called combined loan-to-value, or CLTV.

Your value number matters a lot. Your own guess, a website estimate and a lender's appraisal can all differ. A lender will use an appraisal or another valuation it trusts. Our guide to what determines your home's value explains what moves that number.

How does home equity grow over time?

Two things build equity at the same time.

• Paying down the loan. Each monthly payment pays off a little of the amount you borrowed, called principal. Early on, most of each payment goes to interest. Over the years, more of it goes to principal, so equity builds faster.
• Your home gaining value. When home prices rise, your equity rises too, even if your balance stays the same. Prices can also fall, and that shrinks equity. No one can promise which way they will go.

You control the first one. Extra principal payments, paying every two weeks, or a recast all speed it up. Our early payoff guide walks through each option.

What are the three ways to borrow against home equity?

There are three main tools. Each one works in a different way, and each fits a different need.

Cash-out refinance

You take a new first mortgage for more than you owe. The new loan pays off the old one, and you get the difference in cash at closing. You end up with one loan and one payment. The catch is that the new rate applies to the whole balance, not just the cash you took out. Our Nevada cash-out refinance guide covers the rules for each loan type.

Home equity loan

This is a second loan that sits behind your first mortgage. You get one lump sum and pay it back over a set term, usually at a fixed rate. Your first mortgage does not change. The Consumer Financial Protection Bureau (CFPB) explains it this way:

“A home equity loan (sometimes called a HEL) allows you to borrow money using the equity in your home as collateral.”Consumer Financial Protection Bureau, “What is a home equity loan?” consumerfinance.gov/ask-cfpb

Home equity line of credit (HELOC)

A HELOC works more like a credit card backed by your home. The lender sets a limit. During the draw period, you borrow what you need, when you need it. After that comes the repayment period, when you pay back what you owe. Your plan papers set how long each period lasts. The rate is usually variable, so your payment can change.

A HELOC limit is not a promise. The CFPB warns: “If the value of your home decreases significantly, your lender might decide not to allow you to take out additional credit under your HELOC plan…” If you are counting on the money for a big project, keep that in mind.

Should you pick a cash-out refinance or a home equity loan?

Start with one question: is your current mortgage rate worth keeping?

If your first mortgage has a lower rate than you could get today, a cash-out refinance gives that rate up on your whole balance just to reach a slice of your equity. A home equity loan or HELOC lets you keep the low rate and borrow only the new amount.

If your current rate is about the same as today's rates, or higher, the math can flip. A cash-out refinance puts everything into one loan and one payment. It also gives you a chance to change your loan term.

Closing costs matter too. A refinance has closing costs, and many of them are based on the full new loan amount. Costs vary by loan and by lender, so compare each Loan Estimate. Ask for a Loan Estimate on any loan you are weighing. That is the standard form that lists a loan's estimated costs. Our guide on deciding whether to refinance shows how to find your break-even point, which is how long it takes for savings to pay back the cost.

How much of your home equity can you actually borrow?

In most cases, you cannot borrow all of it. Lenders cap the total of all loans on the home at a share of its value. That cap leaves a cushion in case prices fall. Here are the common limits for a one-unit home you live in.

VA rules are different enough that they have their own page: see our VA cash-out refinance guide. If you own a rental, the limits are lower and the rules differ. Our guide to home equity loans on an investment property covers that case.

Worked example: a Las Vegas home worth $450,000

Here is how an 80% cap works on the same home from above. You owe $270,000.

So even with $180,000 of equity, an owner in this example would top out near $90,000 under an 80% cap, and closing costs come out of that. The other $90,000 stays in the home as the cushion. The lender also checks your credit and your income. Your total monthly debts compared with your income, called debt-to-income ratio, can limit you even when you have plenty of equity.

How much room might you have under a typical borrowing cap?

Enter your numbers to see a rough answer. This calculator does not save or send the numbers you enter.

How do you protect your home equity?

Every equity loan has the same rule underneath it: your home secures the debt. If you cannot pay, you could lose the home. That one fact should guide how you use the money.

• Borrow for things that last. A new roof, a needed repair, or an addition can protect or add to the home's value.
• Be careful with debt payoff. Moving high-interest card debt to a home loan can lower your interest rate. A longer term can still raise the total interest you pay. It only helps if the cards stay paid off. Otherwise you end up with both debts, and the house is on the line.
• Skip short-term spending. A vacation or a car paid off over the life of a home loan costs far more than it looks.
• Keep your own cushion. Just because a lender will lend up to a cap does not mean you should. Equity you leave alone protects you if prices drop or you need to sell.

Can you change your mind after closing?

Usually, yes. For a cash-out refinance, home equity loan, or HELOC on the home you live in, federal law generally gives you three business days to cancel. The clock starts after the latest of three events: closing, getting your cancellation notice, or getting your loan disclosures. For this right, Saturdays count. Sundays and federal holidays do not. This is called the right of rescission. Your lender must give you a written notice that explains it. The right does not apply to the loan you used to buy the home. If you refinance with your current lender, the right may cover only the new money you borrow. Read your notice for the exact deadline.

Is the interest on a home equity loan tax deductible?

Sometimes. The IRS ties the answer to how you use the money and to loan limits. IRS Publication 936 explains the rules for home loan interest. Tax rules change, and your situation is your own, so ask a tax professional before you count on a deduction. We do not give tax advice.