Definition of "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.

image of a real estate dictionary page

Have a question or comment?

We're here to help.

*** Your email address will remain confidential.
 

 

Popular Real Estate Questions

Popular Real Estate Glossary Terms

Characteristic of a trust that prevents the invasion of its principal by the trustees while providing a lifetime income to its principal beneficiary with the rest going to the son's ...

Same as term financial institutions and markets: Institutions acting as intermediaries between suppliers and users of money. The financial markets are where those wanting funds are matched ...

External top of a structure such as for an office building or house. ...

To default on a loan means to intentionally or unintentionally miss several consecutive monthly payments over the course of a few weeks or months. Most borrowers learn the definition of ...

Special court for the purpose of providing fast, inexpensive and informal settlement of small financial claims between plaintiff and defendant. The parties represent themselves. A landlord ...

Appropriateness of the soil for the designated purposes. An example is soil suitable for the growing of vegetables and fruit, or grazing for horses. ...

Early American architecture modeled after the English Georgian architecture having two or three stories with a rectangular design and ample ornamentation often including a widow's walk. ...

See annuity due. ...

Listing of the names of tenants, apartments, or office numbers, and monthly rentals. ...