In this article:
- What Is Home Equity?
- Why Your Home Value May Drop
- What Happens if Your Home Equity Decreases?
Your home equity may decrease as your home's value drops, which can happen for various reasons. Less equity isn't always a cause for concern, but it could limit your options if you want to take out a loan or sell the house. If you're worried and have the means, you could increase your equity by making additional mortgage payments or investing in home improvements.
What Is Home Equity?
Your home equity is the portion of your home's value that you own. You can calculate your home equity by subtracting your mortgage balance from your home's current market value.
For example, if you pay off your mortgage or buy a home with cash, you have 100% equity, or fully own your home. But if you have a 10% down payment and borrow 90% of the purchase price, then you'll have 10% equity in the beginning because your lender owns the other 90% of the home.
Your home equity increases as you pay off your mortgage and when your home's value rises. For instance, if your home is worth $400,000 and you owe $360,000 (90%), then you're left with $40,000, or 10% home equity. If your home's value jumps to $450,000 and you still owe the same amount ($360,000), your equity portion will now be worth $90,000, or 20% of the total.
Conversely, your equity can decrease if you take out a home equity line of credit (HELOC) or home equity loan—types of second mortgages—and when its current value decreases faster than you're paying off your mortgage. If your home's value drops below what you owe, you'll have negative equity, which is also called being underwater or upside down on your loan.
Why Your Home Value May Drop
Home values can drop for a variety of reasons, only some of which you can control. Common causes for dropping home values include:
- Rising mortgage rates: Rising mortgage interest rates can make buying a home more expensive, which decreases demand from potential homebuyers and leads sellers to lower their asking prices.
- Local market conditions: Housing markets can largely depend on local supply and demand. For example, Zillow reports that previously hot housing markets in Boise, Idaho; Austin, Texas; and Raleigh, North Carolina, may start to cool in 2023, as could some urban and vacation areas.
- Climate change: Your home's value could drop if it's in an area that will likely be majorly impacted by climate change. Expected sea level rise has already contributed to declining home values in coastal areas of Florida, and a McKinsey report estimates values could decline 5% to 15% by 2030 in some areas.
- The home's condition: Maintaining a home can be expensive and time-consuming, but if you don't keep up with maintenance, your home's value may decrease as it ages.
If you're curious about your home's current market value, you could get an estimated and automated valuation from various home-pricing websites, such as RedFin and Zillow. Real estate agents may also have access to tools and knowledge of the local area that they can draw on to give you an estimate. An appraiser can offer a more detailed valuation, but you'll often have to pay them, which might not make sense unless you have a specific need for a current appraisal.
What Happens if Your Home Equity Decreases?
Having less equity isn't necessarily a bad thing, especially if you don't plan to sell your home, refinance your mortgage or borrow against your home soon. But declining equity can affect you in several ways:
- You may have fewer options to take out a loan. Home equity loans, HELOCs and cash-out refinances generally limit how much you can borrow based on your equity. Depending on how much your home equity decreases, you might only qualify for a small loan, or might not qualify at all.
- Your HELOC could be reduced or frozen. If you already have a HELOC, your lender may lower your account's credit limit or freeze your account and forbid you from taking out additional draws. You may be able to appeal this decision if you pay for an appraisal that shows your home's value hasn't decreased as much as the lender assumed.
- You might feel trapped in your home. If you have negative equity, you might not be able to sell your home unless you make extra mortgage payments and increase your equity. Otherwise, you may need your lender to agree to a short sale and approve a buyer's offer.
If you're worried about your home equity decreasing, you could look for ways to increase your equity, such as making additional mortgage payments and investing in home improvements. However, you'll need to determine if putting more money into your home as its value decreases is a good idea.
Increase Your Credit Score and Options
Establishing equity in your home can give you options if you need to move or take out a loan, but home equity loans aren't your only option. For example, you could finance a large purchase with an intro 0% APR credit card to avoid paying interest during a promotional period. Or, take out a personal loan for a home improvement to increase your home's value and your equity.
Qualifying for these unsecured financing options depends largely on your income and credit. You can check your credit score for free with Experian, find out what's impacting your score the most and make a plan for improving your score.
