What is residential equity?
Home equity is the value of the owner’s interest in their home. In other words, it’s the current market value of the building minus the liens attached to that property. The amount of equity in a home or its value fluctuates over time as payments are made on the mortgage and market forces affect the current value of that property.
Key points to remember
- Home equity is the value of the owner’s interest in their home.
- A homeowner can take advantage of their equity in the form of collateral to obtain either a home equity loan, a traditional home equity line of credit (HELOC), or a fixed rate HELOC.
- A large down payment on a house (more than 20%) will immediately give the owner more equity in his house than a smaller down payment.
How Housing Equity Works
If part or all of a house is purchased with a mortgage, the lending institution has an interest in the house until the loan obligation is met. Home equity is the portion of the current value of a home that the owner actually owns for free.
Equity in a home can be achieved either by a down payment on the initial purchase of the property, or by mortgage payments – as a contractual part of this payment will be affected to lower the principal owed. Homeowners can take advantage of the appreciation in property value as this will increase the value of their equity.
Home equity is an asset and is considered part of equity, but it is not a liquid asset.
Ways to Take Advantage of Home Equity
Unlike other investments, home equity cannot be quickly converted into cash. The equity calculation is based on an assessment of the current market value of your property. However, this appraisal does not guarantee that the property will sell for this price.
A homeowner would be able to use their real estate capital as collateral to obtain either a home equity loan, a home equity line of credit (HELOC), or a fixed rate HELOC.
A home equity loan, sometimes called a second mortgage, usually allows you to borrow a lump sum on your current equity at a fixed rate over a specified period of time. Many home equity loans are used to finance large expenses such as home repairs or tuition.
A home equity line of credit (HELOC) is a revolving line of credit generally with an adjustable interest rate that allows you to borrow up to a certain amount over a period of time. HELOCs work in a similar way to credit cards where and you can continuously borrow up to an approved limit while paying off the balance.
An example of net worth
If a homeowner buys a home for $ 100,000, with a 20% down payment and covers the remaining $ 80,000 with a mortgage, the homeowner has a home equity of $ 20,000. 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 owns $ 25,000 in equity in the home.
If the market value of the house had increased by $ 100,000 in those 2 years and the $ 5,000 from mortgage payments were applied to the principal, the owner would then have a net worth of $ 125,000.