What Is Home Equity?

Home equity is the difference between the market value of a house and the amount borrowed or owed on it. Most people think of equity as the difference between the mortgage and the value of the home, which is accurately inaccurate.

Equity is determined by subtracting the amounts of all debts or obligations secured with the property from the property's value. Liens can affect the amount of equity available just like mortgages and equity loans can. This is why a title search is usually run when a mortgage or home equity loan is taken out. The lender wants to know if there are any outstanding liens on the property that will reduce the equity.

Equity and Borrowing

Equity determines how much can be borrowed against a home. An equity loan, or line of credit is secured by the equity. The amount available is based on the current amount of equity in the home.

This is why people can borrow more against their home if they pay down their mortgage. The more equity available the larger the potential home equity loan, or line of credit. People taking advantage of such lending should realize that they are reducing their equity and their future borrowing potential by taking advantage of such loans.

That is why it is often better to take out a Home Equity Line of Credit or HELOC than a straight loan. A person with a line of credit only has to pay off the funds he, or she actually borrows. The full amount of a loan must be paid off even if there are funds left over. Therefore, it would be better to use a HELOC to cover the cost of home repairs or other emergency expenses than a loan.

Underwater Houses

The term "underwater" is real estate industry slang for a situation in which the amount borrowed against a home exceeds the property's value. This situation can occur because the amount of equity available is based on a home's value. If the value of the home falls the amount of equity drops. It is entirely possible for a property that had a lot of equity to have no equity a few years later because of drops in value.

Many persons who find themselves with underwater houses were operating under the delusion that real estate never loses value. Like any other investment real estate can lose its value and even lose value very quickly. Such drops in value can quickly wipe out equity even on very valuable properties.

This is why homeowners should be very careful about using home equity loans, or lines of credit. It is always a good idea to take a look at the local real estate market and the prices homes are selling for in your area before using such lending. If home values have been dropping it would be a good idea not to use equity.

Home Equity and Reverse Mortgages

Equity is also the basis of reverse mortgages, which are actually annuities purchased with equity loans. In this arrangement a person who is over 62 uses the equity in his or her home to purchase an annuity that provides a guaranteed lifetime income. The amount of the reverse mortgage is determined by the equity in the person's home.



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