What it means
Home equity is the part of a property you own outright, found by subtracting what you owe from what the home is worth. When prices rise or the mortgage is paid down, equity grows.
Withdrawing equity means borrowing against that growth and using the proceeds for something else. There are several ways to do it.
A cash-out refinance replaces the old mortgage with a bigger one and pays the difference to the owner in cash, while a home equity loan or line of credit adds a second loan on top of the first. In each case, the homeowner owes more afterwards than before.
People use the money for home improvements, paying off higher-interest debts, education or business funding. Used well, it can be a cheap source of finance, because mortgage rates are often lower than rates on credit cards and personal loans.
Used badly, it can leave households with less equity and larger payments. For the wider economy, MEW matters because it can act as a source of spending.
In periods of rising house prices, households may borrow against their gains and spend more, which supports growth. If prices then fall, the debt remains while the equity disappears, which can cause serious strain, as the 2007 to 2009 crisis showed.
Lenders limit how much can be withdrawn, typically by requiring that the new loan stays below a set share of the home's value. Borrowers also pay closing costs, which reduce the cash they actually receive.
Before withdrawing equity, a household should ask whether the purpose will pay back more than it costs. Improvements that raise the value of the property or clearing debt that costs much more in interest can make sense, whereas spending on short-lived items rarely does.
It also helps to keep enough equity as a cushion in case prices dip.
In practice
Real-world examples.
Example
A homeowner whose property has doubled in value uses a cash-out refinance to raise $60,000. She spends it on a new roof and kitchen, which add to the value of the house. A valuer later confirms that the home is worth more than before the work. Her monthly payment rises, but she judges the improvements worth the extra cost.
Example
A small business owner takes a home equity line of credit to buy inventory before a busy season. He draws $25,000 and repays it from sales over six months. He knows that if the business fails, his home is at risk.
Example
An economist studying household spending notes that equity withdrawal rose during a long run of house price growth. When prices later fell, withdrawals dropped sharply and consumer spending weakened. She uses the pattern to show how housing wealth affects the wider economy.
Formula
Calculation
Cash Received = New Loan - Payoff of Old Mortgage - Closing Costs
Suppose a home worth $500,000 has a mortgage balance of $240,000. The owner refinances into a new $350,000 loan, which is 350,000 / 500,000 = 70% of the home's value. The old loan is paid off, and closing costs are $5,000. Cash Received = 350,000 - 240,000 - 5,000 = $105,000. The owner's debt rises from $240,000 to $350,000, so the equity falls from 500,000 - 240,000 = $260,000 to 500,000 - 350,000 = $150,000.Case study
Seen in the real world.
The Moreno family is an illustrative, fictional household that owned a home worth $400,000 with a mortgage of $150,000. They wanted $50,000 to pay off credit cards charging 22% interest.
They took a cash-out refinance of $210,000, which paid off the $150,000 mortgage, covered $4,000 of costs and left $56,000 in cash. The cards were cleared, and their blended interest cost fell sharply.
A year later they had used the card limits again and owed $20,000 more. The illustrative lesson is that equity withdrawal can be a sensible way to lower interest costs, but only if spending habits change and the freed credit is not simply filled again. They later closed two of the cards and set a monthly budget to avoid repeating the pattern.
Watch out
Common mistakes.
- Treating home equity as free money, when every dollar withdrawn is a loan that must be repaid with interest.
- Ignoring closing costs, which can take thousands of dollars from the cash actually received.
- Using the funds for spending that loses value, when secured debt puts the home at risk if payments are missed.
Questions
People also ask.
What is the difference between a cash-out refinance and a home equity loan?
A cash-out refinance replaces your first mortgage with a larger one, while a home equity loan is a separate second loan alongside the existing mortgage.
Is the cash taxable?
Generally the money is borrowed, not income, though tax treatment of the interest depends on how it is used and on local rules.
Why do economists track MEW?
Because the cash can fuel consumer spending, and large amounts of borrowing against homes can leave households and lenders exposed if prices fall.
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