Home Equity - Explained
What is Home Equity?
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Table of ContentsWhat is Home Equity?Why Does Home Equity Matter?Home Equity ExampleWays to Leverage Home EquityAcademic Research
What is Home Equity?
In simple terms, home equity is the proprietors equity in their home, which is nothing but the total value of the property minus liens. A homeowner can acquire home equity in two ways: 1. By paying a down payment that guarantees an outright ownership claim to a percentage of the property, or 2. By paying mortgage instalments for a fixed period, thereby assuring a gradual increase of ownership. Besides any appreciation in market value of the property will also add to the home equity value.
Why Does Home Equity Matter?
Suppose a homeowner purchases a home via a mortgage with an arrangement that he will be paying the loan back on an Equated Monthly Installment (EMI) basis. A year later with 12 installments paid, the homeowner has cleared a percentage of the loan, which also implies that he/she is now in clear ownership of a corresponding percentage of the property. That part of the property that is now in clear possession of the homeowner is his/her home equity.
Home Equity Example
Let us say Mr Smith bought a property worth $200,000 with an outright down payment of $40,000 (20%) with a mortgage for the remaining 80% value of the property payable at $1000 per month. His immediate home equity after the down payment will be $40,000. A year later with 12 instalments having been paid, Mr Smiths home equity will increase to $52,000. Now, let us assume that that the market value of the house increased by $10,000 during that year. In this case, Mr Smiths home equity after a year of purchase will stand at $62,000.
Ways to Leverage Home Equity
Holding home equity as an asset is intrinsically different from holding other forms of assets. For one, home equity is not a liquid asset and as such, it cannot be monetized as instantly or conveniently as other assets. Also, the monetary value of a home equity is based on market speculations and hence, in the event of a sale of the equity, there can be a huge discrepancy between the speculative market value of the home equity and the price it actually manages to fetch. That is not to say that home equity cannot be leveraged at all. Attaining a home equity loan or a home equity line of credit (HELOC) with the home equity as a collateral is an effective means of bringing liquidity to what is otherwise a fixed asset. In fact, a home equity can be utilized as an essential instrument for financing big ventures, mortgaging other properties and even taking out personal loans.