What Is Home Equity?

• Home equity is the amount of a home's value that a person owns, as opposed to home value that is still owed on a mortgage or loan. In its simplest terms, home equity can be though of as the amount of principal that has been paid off toward the purchase price of a home. For example, if you purchased a $200,000 home and have made mortgage payments that have paid off 10 percent of the principal, your equity share would be $20,000. Any down payments made on a home immediately become equity, since a down payment is essentially the purchase of a small percentage of a home's full value.
  
  Using the sale price of a home as the barometer of equity is not entirely accurate, however, since any increase or decrease in the value of the home will proportionally change the "amount" of equity. Taking the previous example, if you have paid off 10 percent of your loan, but the value of the home also increased by 10 percent over that period, the value of your equity would be $22,000, rather than $20,000. For most people, home equity accounts for a large proportion of overall net worth, which is why stagnating or declining housing prices has a huge economic impact.
  
  

Buying Versus Renting

• Home ownership is usually preferable to renting, because mortgage payments build equity in small increments over time, rather than disappearing into pockets of a landlord. While living in a home or condo with a mortgage may feel like renting an overpriced apartment, it is usually economically advantageous in the long run, since homes can be sold--often at a profit--at some point in the future. Renting can, however, be an economically superior alternative to purchasing and building equity in a home if the interest, taxes and insurance were to exceed the amount it would cost to rent.
  
  

Home Equity Loans

• Perhaps the most common reference to home equity you may come across in your day-to-day activity is the home equity loan. A home equity loan is a loan that uses the equity built up in a home as collateral against the money borrowed. You can often take out a home equity loan in an amount up to the full value of your home's equity. A home equity loan or line of credit can be thought of a second mortgage: borrowed money that must be paid back in order to regain home equity. While using home equity to secure a loan can be useful in times of economic need, it is usually best to avoid giving up equity.