What Is Home Equity?
When we look at home equity, we instantly think of home equity loans or home equity lines of credit. There is a reason for that, and we’ll get to it in a bit. Firstly, however, homeowners must understand what home equity is. Home equity can be defined as the interest a homeowner has in a home. In other words, how much money did the homeowner pay for the house so far? The reason we say so far is that home equity is a value that is affected over time.
Regarding homebuyers that decide to purchase a home, a high percentage of them need a loan, or mortgage, to make the purchase. If they're buying a home and don't have very much money for the down payment, they can take out a mortgage. Now, we can already talk about the homeowner’s home equity regarding the down payment. The down payment is how home equity starts, but let’s go into details about this.
How does Home Equity Work?
We already established that a vast majority of homebuyers take out mortgages to purchase a home. When they take out a mortgage, they also pay a down payment for the house. That is the first financial addition that goes into home equity. The homeowner then makes monthly payments into the mortgage or loan that proportionally cover the premium, so the home equity increases. With each mortgage payment, the homeowner owns more and more of the house that he/she is purchasing. This is why home equity is, in reality, the portion of the home’s value that the homeowner owns at any given time.
An added benefit of home equity is that the value of the property can appreciate over time, which will increase the home equity as well. As the property’s value appreciates, the portion of the property already paid and part of the home equity will appreciate as well. This can mean that when a homeowner takes out a loan for a property valued at $300,000 and pays $100,000 towards a down payment, that downpayment becomes equity in the home. Then, let’s say they pay around 60% of their mortgage payment over a period of time which would increase their home equity to $220,000, without the potential of appreciation. However, with appreciation, they could find out that the property’s value increased to $350,000. Their home equity, after 60% of their loan obligation is paid, increased to $270,000 because of the appreciation.
Where does Home Equity Matter?
One significant advantage of home equity happens when appreciation rates increase, as mentioned above. There are, however, many ways in which home equity has a significant effect.
In the beginning, we mentioned taking home equity loans, and so on. In fact, there are several types of loans that are impacted by home equity.
- Home equity loan - where the homeowner takes out a fixed-rate loan on their home equity for a fixed period of time. It is also called a second mortgage.
- Home Equity Line Of Credit (HELOC) - where the homeowner takes out an adjustable-rate revolving line of credit on their home equity.
- Fixed-Rate Home Equity Line Of Credit - where the homeowner takes out a fixed-rate home equity loan on their home equity. It is considered a hybrid between a HELOC and a home equity loan.
Popular Real Estate Questions
Popular Real Estate Glossary Terms
In taxation losses that can offset ordinary income. Assume john owns and operates an apartment house. Minor tenant damage to the property is used to offset rental income. ...
Person, such as the beneficiary of a deed, asking that he be informed if the property is foreclosed by someone else. ...
If you are a real estate investor and you come across this term, you might wind up wondering … What is the operating expense ratio? The operating expense ratio (OER) is a way for ...
Section of the Internal Revenue Code relating to depreciation. Capital improvements made to real property are depreciable. ...
Founded in 1947 and located in Washington, DC, the NAREB has 7,500 members with 15 regional groups and 6 state groups. It offers certification programs for members of the real estate ...
Refinancing by a borrower in which the new interest rate takes into account the interest rate on the prior loan and prevailing current interest rate in the market. ...
The metaverse definition can be described as a digital environment that is simulated through the use of augmented reality (AR), virtual reality (VR), and blockchain technology, combined ...
Gift of real property as stipulated in a will. ...
In real estate, a buffer zone refers to an area of land that acts as a transitional space between two different types of land use or properties. It’s like a neutral ground that ...
Have a question or comment?
We're here to help.