How is home equity calculated?

Put very simply, your home equity is the worth of your home, minus the amount still owing on your mortgage. For example, let's say you bought a house that cost $280,000 with the help of a $200,000 mortgage from the bank. Some years have gone by, you have paid off a good part of the loan to the bank, and you still have $100,000 left to pay. Because houses usually appreciate in value as time goes by, your home's worth has probably risen in that time -- as well as from any home improvements you may have carried out. If your home is now worth $320,000, then by subtracting the $100,000 that you still owe the bank, you can figure that you now have a home equity of $220,000.

Your home equity is an important figure if you are considering requesting a second mortgage or other loan from the bank. The value of your home becomes the collateral for the amount you want to borrow. The bank knows that if for some reason you are unable to repay the loan, they can seize your house, or require you to sell it to pay off the money that is owed.

In general, home equity loans or second mortgages are fairly large, but for a smaller amount than the original mortgage. Additionally, they are usually for a shorter period of time, although in some cases, they can be paid off over as long as 30 years.

Often, a home equity loan is requested to cover the cost of college tuition for children, or for a major home renovation. In cases like this, you borrow a fixed sum from the bank and repay it over time at a fixed interest rate. When you don't know the exact amount you need to borrow, it may be possible to have a credit line from the bank, up to a particular amount that is set according to your home equity.