What is Home Equity?
Home equity is the value of the homeowner’s interest in their home. In other words, it is the real property’s current market value less any liens that are attached to that property. The amount of equity in a house or its value fluctuates over time as payments are made on the mortgage and market forces play on the current value of that property.
- Home equity is the value of the homeowner’s interest in their home.
- An owner can leverage their home equity in the form of collateral to attain either a home equity loan, fixed-rate or traditional home equity line of credit (HELOC).
- A large downpayment on a home (over 20%) will provide a homeowner with immediately more equity in his or her home than a smaller downpayment.
How Home Equity Works
If a portion, or all, of a home, is purchased by means of a mortgage, the lending institution has an interest in the home until the loan obligation has been met. Home equity is the portion of a home's current value that the owner actually possesses free and clear.
Equity in a house can be attained either by a down payment during the initial purchase of the property or with mortgage payments––as a contracted portion of that payment will be assigned to bring down the outstanding principal still owed. Owners can benefit from property value appreciation as it will cause their equity value to increase.
Home equity is an asset and is considered a portion of net worth, but it is not a liquid asset.
Ways to Leverage Home Equity
Unlike other investments, home equity cannot be quickly converted into cash. The equity calculation is based on a current market value appraisal of your property. However, that appraisal is no guarantee that the property would sell at that price.
An owner would have the possibility to leverage their home equity in the form of collateral to attain either a home equity loan or a home equity line of credit (HELOC), or fixed-rate HELOC.
A home equity loan, sometimes referred to as a second mortgage loan, usually allows you to borrow a lump sum against your current home equity for a fixed rate over a fixed period of time. Many home equity loans are entered into to finance large expenditures like home repairs or college tuition.
A home equity line of credit (HELOC) is a revolving credit line of credit usually with an adjustable interest rate which allows you to borrow up to a certain amount over a period of time. HELOCs work in a manner similar to credit cards where and you can continuously borrow up to an approved limit while paying off the balance.
An Example of Home Equity
If a homeowner purchases a home for $100,000, with a 20% down payment and covers the remaining $80,000 with a mortgage, the owner has equity of $20,000 in the house. If the market value of the house remains constant over the next 2 years, and $5,000 of mortgage payments are applied to the principal, the owner now possesses $25,000 in home equity.
If the market value of the home had increased by $100,000 over those 2 years, and that same $5,000 from mortgage payments were applied to the principal, the owner would then have a home equity of $125,000.