What happens to your equity if home prices drop?

Equity is the part of your home you own outright: the home's value minus your mortgage and any other loans against it. You build equity two ways, by paying down your loan and by your home rising in value. When values fall, the second part works in reverse.

Say your home is worth $400,000 and you owe $300,000. You have $100,000 in equity. If prices drop 10%, the home is worth $360,000. You still owe $300,000, so your equity falls to $60,000.

Hypothetical example; figures are for illustration only.

• You still own the home and keep paying the same loan
• A fixed-rate payment stays the same
• Refinancing or taking cash out may be harder, since there's less equity to work with
• Selling may net you less, especially soon after you bought
• If you don't need to sell, a drop on paper may recover over time

If you borrow most of your equity and prices fall, you could end up owing more than the home is worth. This is called being underwater. It can make it hard to sell without bringing cash to closing, and hard to refinance.

That's why it helps to leave a cushion when you borrow against your home. Think about how you'd feel if values dipped right after you borrowed, and whether you could still sell or refinance if your plans changed. A smaller loan gives you more room to ride out a slow market.

Home equity lines of credit (HELOCs) are a different product. With a line, the lender may be able to freeze or reduce your available credit if your home's value drops significantly. CapCenter doesn't offer HELOCs.

A fixed-rate home equity loan works differently. You get the money in one lump sum at closing, and your rate, payment and term stay the same even if prices fall.

• Leave an equity cushion instead of borrowing the maximum
• Pay down principal when you can
• Avoid borrowing against your home for short-term wants
• Keep an emergency fund so you aren't forced to sell in a down market
• Choose a fixed rate if you want a payment that won't change