What is Home Equity?

Published by Thomas Herold in Banking, Investments, Real Estate

'Home Equity' is explained in detail and with examples in the Investments edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

Home Equity refers to those assets which result from the home owner’s stake in the house itself. Calculating up the equity of the home is not difficult. One simply takes any remaining loan balances and subtracts them off of the market value of the property. It is very possible for the equity in a home to grow with time, in particular when the value of the property rises and also as the balance of the loan becomes gradually paid down over time.

An easier way to think of this home equity is as the part of the property which the home owner actually owns. The lender is always the interest holder in a given property that includes a mortgage secured by the home. This is the case all the way up to the point where the home owner pays off completely the mortgage loan balance. It is no exaggeration to state that the equity in a home is commonly the most valuable asset for most home buyers. Equity in a home allows for a home owner to take out a second mortgage at later points in the life of the mortgage loan.

It is always helpful to look at a real-world example to better understand difficult and challenging concepts such as this one. If a home buyer obtained a house for $250,000 and dutifully made a full 20 percent down payment, then he would likely obtain a $200,000 mortgage loan to pay the remaining balance on the house. The home equity at this initial point would equate to the down payment of $50,000. The home’s value is $250,000, but the buyer only contributed $50,000 as an upfront down payment towards the purchase price.

In the unlikely event that the value of the home doubled, it would then be worth $500,000. Yet despite this windfall increase in value, the mortgage is still only $200,000. This would mean that the home equity increased to a massive $300,000. The equity stake then would have risen to 60 percent. Figuring this up is simply a function of dividing the balance of the loan by the market value to subtract the end result from one. Then the person must convert the resulting decimal into a percentage. While the balance on the mortgage has not grown, the equity in the home has massively increased.

There are several ways that a home owner might increase the equity within his home. The simplest way is to pay down the loan balance at a faster rate than only the monthly mortgage payment amounts. Slowly over time, these monthly payments will go more and more towards the principal repayment. It means that all else being equal, a person builds up the equity in the home at a rate that increases gradually every year. By making extra payments each month, which all accrue against the principal only, this equity grows faster and eventually exponentially so.

Another way equity accrues to a home is through home price appreciation. As the home grows in value (thanks to natural area appreciation or home improvement projects) the equity in the property similarly grows. Equity is always a handy asset, which makes it an integral part of the person’s aggregate net worth. In an emergency or on a rainy day, home owners can simply withdraw large lump sum amounts from the equity of the house one day. This wealth might also be simply passed along down the family line to the owners’ heirs as well.

There are two principle ways to withdraw the equity value from a house. It might be taken as a home equity loan or a home equity line of credit (called a HELOC). Either one will allow an individual to utilize the proceeds for practically anything they wish. This might be for home improvements, vacations, retirement, or university level education as a few examples.

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The term 'Home Equity' is included in the Investments edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.