What is home equity?

[valerie]

My understanding of this has always been... say you purchase a home for

$350,000, you pay on it for 5 years or whatever, get it down to $300,000

and have then $50,000 in EQUITY. Someone else says that it is the amount

your home appreciates over time. What it is worth over and above what you

paid for it.

Before I end up in (or STARTING) WWIII can anyone clear this up? Any

mortgage brokers out there or home equity loan managers er sumthin'?

[A Karenina]

Good morning Valerie,



We can't have you starting WW3 over this. I'm not a mortgage lender but I am an accountant. Please talk with a few lenders before making any decisions and get some hard numbers. Always. (LOL, I'm so bossy!)



Equity is basically the piece of something that you personally own. Think on that for a second - I probably didn't phrase it well.



The most basic accounting formula which rules our profession is Assets equals Liabilities plus Equity. Let's say that your house is valued at $100,000 (asset) and you currently owe $80,000 on the mortgage (liability). That means your equity is $20,000 only in the strictest accounting sense.



This basic formula does NOT consider the fact that things either appreciate or depreciate.



Homes usually appreciate or increase in value. Housing prices go up, perhaps home improvements have added value to your home, perhaps the neighborhood is in the process of "upscaling" itself, etc. These kinds of events would increase the asset portion of the formula - and consequently this would increase the equity portion as well. Make sense?



If your home was originally valued at $100,000 but today is valued at $125,000, then your equity jumps from the $20,000 to $45,000.



Home equity is basically the fair market value less any claims (mortgages) against it.



Since the value normally increases over time and the claims against it decreases over time, property investments are one of the wisest decisions you can make.



You should consider any home equity loan to be a second mortgage. It is a claim on your poroerty, and defaulting on the loan allows the lender to take possession of your property. However, it can also be a wise investment if you have substantial untapped equity and you plan to either 1) dramatically increase the value of the property through an addition or other improvement or 2) pay off high interest debt.



Let me know if you'd like examples to demonstrate that. It's easy enough to do - just remember that the A = L + E formula can apply to a portion of your finances and to all of your finances. People should always have a pretty clear idea of their net worth at all times...simply the market value of what they own less everything they owe to others equals their equity (or profit).



On appreciation versus depreciation ~ some things increase in value over time but other things decrease. Cars are an excellent example of a depreciable asset. The moment you drive a car off the lot, it decreases in value. If you bought a new car for $18,000 and then tried to sell it immediately, you will not get the $18,000 for it. It is already worth less than what you paid for it.



The only reason I mention that is because so many people trade in their cars while they still owe money on it. They are basically refinancing their original loan - which increases the price of the new car they just bought. Makes no sense whatsoever.



Anyway, I hope this helps somewhat. Please let me know if you would like me to clarify anything. Hopefully, someone with mortgage lending experience will be able to round out my reply. Be cautious and wise - you work too damn hard to take these things lightly.

[valerie]

Thank you, thank you, thank you. That does clear it up for me. So I guess

I was right in "the strictest accounting sense" but he who shall remain

nameless was right in what he said, too!!

I knew that about cars, though, mine turns 19 this month!!

So if your house depreciates for the amount of equity you have in it, then

that means you've lost your equity?

(Didja notice the Google ads change when I typed in "equity"?)

[A Karenina]

valerie wrote: Thank you, thank you, thank you. That does clear it up for me. So I guess

I was right in "the strictest accounting sense" but he who shall remain

nameless was right in what he said, too!!
LOLOL!! Both you and The Nameless One are right. Wish that happened more often - to me at least!



valerie wrote: So if your house depreciates for the amount of equity you have in it, then

that means you've lost your equity?
Yes (so long as the depreciation is greater than the amount you are paying off, or the decrease to your liability)...how depressing! If your house is depreciating, then you may want to fight hard to change that, if you can. Or cut your losses and get out.



I rent an old house that was converted into apartments. It's in a residential neighborhood that has seen some dramatic changes over the past 10 years.



This used to be a huge drug neighborhood, but as the houses depreciated in value, the homeowners got mad (good for them!). They organized, worked with the police and local businesses, and cleaned up the neighborhood. Their houses are now appreciating each year.



It's now a quiet family neighborhood filled with families walking their dogs, and small businesses along the main thoroughfare.



I'm not sure what your situation is, or if you're just discussing things in general. But I hope that everything works out for you.

[valerie]

It was more a "just out of curiosity" type thing. Our house thank goodness

has appreciated a lot. But I wondered about people when the main employer

in town shuts down the plant... stuff like that.

Or people like my brother and his wife, who haven't owned their house very

long and are relocating to Phoenix, Arizona. He did a TON of work to their

house, looks great... but having a hard time finding buyers. 'Course, time

of year and all that.

Thanks again for the info.

[gmc]

posted by valerie

It was more a "just out of curiosity" type thing. Our house thank goodness

has appreciated a lot. But I wondered about people when the main employer

in town shuts down the plant... stuff like that.


If they are really unlucky they end up in negative equity-owing more than the house is worth. In the UK the problem was bad enough in some areas that they introduced special schemes to help people get out of it. Some new house builders will also do a part exchange scheme. other than that you sit, hope you keep your job and eventually prices recover.

[Erinna1112]

valerie wrote: My understanding of this has always been... say you purchase a home for

$350,000, you pay on it for 5 years or whatever, get it down to $300,000

and have then $50,000 in EQUITY. Someone else says that it is the amount

your home appreciates over time. What it is worth over and above what you

paid for it.
The second of these is correct. Your equity in your home is the difference between its market value and the current balance on your mortgage. Here's a for-instance:

My house is now worth $120,000. I paid $103,000. I currently owe $78,000.

My equity in this house is $42,000 (the difference between the current value and the current loan balance), NOT $25,000 (the difference between the purchase price and the current loan balance).