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Home equity

From Wikipedia, the free encyclopedia

Home equity is the homeowner’s financial interest in their property, calculated as the difference between the property's current market value and the total outstanding balances of all loans secured by the home.

In the United States, it is a major source of wealth accumulation with the majority of middle class wealth being held in home equity which totals over $35 trillion overall.

Definition and function

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Home equity is defined as the market value of a homeowner's unencumbered interest in their real property, that is, the difference between the home's fair market value and the outstanding balance of all liens on the property.[1] It is summarized by the accounting identity, value − debt = equity. In economics, home equity is sometimes called real property value.[2]

Homeowners acquire equity in their home from two sources. They purchase equity with their down payment and the principal portion of any payments they make against their mortgage. Definitionally, this results in the immediate creation of home equity in the amount of the down payment at the time of purchase with equity increasing with each payment (in cases of standard amortizing loans).[3] The property's equity increases as the debtor makes payments against the mortgage balance.[1]

Equity also increases as the property value appreciates as the value of the property increases while the debt remains unchanged.[1] Conversely, home equity may decrease on a property should valuations decline. In extreme cases, this can result in negative equity, often referred to as mortgages which are "underwater" or "upside down".[4] In 2012, approximately 20% of mortgage holders were underwater; negative equity was most concentrated in Nevada where 61% of mortgages were upside down.[5] Arizona (48%), Florida (44%), Michigan (35%), and Georgia (33%) also all showed a high percentage of homeowners with negative equity.[5] Negative equity greatly increases the risk of foreclosure and default since a home sale will no longer fully cover the debt.[6]

Home equity as an investment

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As of March 2025, homeowners in the United States have over $35 trillion in home equity according to the Federal Reserve Bank of St. Louis.[7][8]

Since the mid 1900s, home equity has been the primary strategy for the American middle class to build household wealth.[9] In most Americans' portfolios, their home is their largest asset.[10]

Home equity represents between 50% and 70% of net wealth for Americans in the three middle income quintiles.[9] In the aggregate, home equity accounts for 43% of net worth for the median household.[11] At the turn of the century, home equity's median share of net wealth among households with positive net worth was 27.2% with an average of 35.3%.[12]

Home equity is illiquid.[13][14] As wealth on paper and not cash in hand, it cannot be readily spent or used for purchases in its current form. An owner must typically sell the property or utilize it as collateral to convert equity into liquid funds.[8] However, rise in home values and its use as a "forced savings plan" contribute to record wealth disparity between homeowners and non-owners with homeownership viewed as a key part of the American Dream separating the middle class from the poor.[15][16][17][18] The median net worth among homeowners was approximately $400,000 in 2024 compared to $10,000 for renters.[19]

Property buyers typically look to purchase properties that will grow in value, causing the equity in the property to increase, thus providing a return on their investment when the property is sold.[20] Pessimistic buyers typically opt for higher leverage through smaller downpayments to limit financial exposure when household needs dictate property size; this pattern is especially pronounced in markets with lower default costs or during anticipated housing downturns[20]

Home equity as collateral

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Home equity management refers to the process of using equity extraction via loans, at favorable, and often tax-favored, interest rates, to invest otherwise illiquid equity in a target that offers higher returns. Home equity may serve as collateral for a home equity loan or home equity line of credit. Many home equity plans set a fixed period during which the homeowner can borrow money, such as ten years. At the end of this “draw period,” the borrower may be allowed to renew the credit line. If the plan does not allow renewals, the borrower will not be able to borrow additional money once the period has ended. Some plans may call for payment in full of any outstanding balance at the end of the period. Others may allow repayment over a fixed period, for example, ten years.

References

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  1. ^ a b c "Homeowners' Equity Remains High". FHFA.gov. Retrieved 2025-04-18.
  2. ^ Mehmet Odekon (2015). Booms and Busts: An Encyclopedia of Economic History from the First Stock Market Crash of 1792 to the Current Global Economic Crisis. Routledge. pp. 554–. ISBN 978-1-317-47576-7.
  3. ^ "Understanding your home's equity – My Home by Freddie Mac". myhome.freddiemac.com. Retrieved 2025-04-21.
  4. ^ Smith, Jennifer (2011). "Mortgage Foreclosures, Mortgage Morality, and Main Street" (PDF). Journal of Civil Rights and Economic Development. 25 (3).
  5. ^ a b "Negative Equity Concentrated in a Few States". Brookings. Retrieved 2025-04-21.
  6. ^ Low, David (February 23, 2022). "What Triggers Mortgage Default? New Evidence from Linked Administrative and Survey Data". Consumer Financial Protection Bureau – via FDIC.gov.
  7. ^ "Households; Owners' Equity in Real Estate, Level". fred.stlouisfed.org. 2025-03-13. Retrieved 2025-04-21.
  8. ^ a b "Issue Spotlight: Home Equity Contracts: Market Overview". Consumer Financial Protection Bureau. 2025-01-15. Retrieved 2025-04-21.
  9. ^ a b "Rethinking homeownership incentives to improve household financial security and shrink the racial wealth gap". Brookings. Retrieved 2025-04-21.
  10. ^ Goetzmann, William; Spaenjers, Christophe; Van Nieuwerburgh, Stijn (2021). "Real and Private-Value Assets". The Review of Financial Studies. 34 (8): 3497–3526. JSTOR 48769642.
  11. ^ Maki, Dean. "Retiring on the House? Cross-Cohort Differences in Housing Wealth". Redefining Retirement: How Will Boomers Fare?. Oxford University Press. ISBN 9780199230778.
  12. ^ "Housing Wealth and Household Net Wealth in the United States: A New Profile Based on the Recently Released 2001 SCF Data" (PDF). Joint Center for Housing Studies at Harvard University. 2003.
  13. ^ Kaul, Karan; Goodman, Laurie (2017). Seniors’ Access to Home Equity (PDF). Washington, DC: Urban Institute.
  14. ^ Guo, Sheng (2021). What Did Homeowners Do with Home Equity Borrowing? Contemporaneous and Long-term Effects (PDF). Miami, Florida: Florida International University.
  15. ^ Choi, Jung Hyun; Zinn, Amalie (2024-04-18). The Wealth Gap between Homeowners and Renters Has Reached a Historic High (Report). Urban Institute.
  16. ^ "Homeownership Is Not Just A "Housing Issue" | Recent News | News Center | Research and Impact | Goldman School of Public Policy | University of California, Berkeley". gspp.berkeley.edu. Retrieved 2025-04-21.
  17. ^ Young, Caitlin; Zinn, Amalie; Choi, Jung Hyun (2023-06-26). Rethinking Homeownership as “the American Dream” (Report). Urban Institute.
  18. ^ Rohe, William M.; Watson, Harry L. (2007). Chasing the American Dream: New Perspectives on Affordable Homeownership. Cornell University Press.
  19. ^ "The wealth gap between homeowners and renters is huge, a new report says". Harvard Kennedy School. 2025-04-04. Retrieved 2025-04-22.
  20. ^ a b Bailey, Michael; Davila, Eduardo; Stroebel, Johannes (2019). "House Price Beliefs And Mortgage Leverage Choice" (PDF). Review of Economic Studies. doi:10.1093/restud/rdy068.


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