Home equity, by definition, is the difference between the value of a property and the amount the borrower owes. Through paying down the debt on a mortgage, a borrower essentially pays for a portion of the home’s equity, and once the mortgage has been fully repaid, the homeowner will own all of the equity within the property.
For example, if a homeowner purchases a home for $200,000 and still owes $100,000, he or she owns 50% of the equity within the property, totaling at $100,000.
Note that equity does not necessarily mean the amount paid into the mortgage; if a borrower’s home value increases, he or she will own this additional equity and the total equity will be greater than the total mortgage payments. Using the same example, if the homeowner’s property value increased to $250,000 and $100,000 remains on the mortgage debt, he or she would own $150,000 in equity, totaling 60%. Similarly, if the property’s value decreases to $150,000, the borrower would own $50,000 of equity, with only 33%. Understand that "equity" is different from "profit or gains." If you purchased a home for $200,000, paid cash and owe nothing, but today's value is $150,000, you would have $150,000 equity. However, your profit or gain would be a negative -$50,000.
When purchasing a home, a borrower will gain equity each time he or she makes a monthly mortgage payment. Although equity often remains untouched within a property, several loan programs offer homeowners the ability to access this equity, essentially selling it back to the bank or lending institution in exchange for cash. These programs include a home equity loan, home equity line of credit (HELOC) and a reverse mortgage.
Removing the equity stored in a home can have substantial consequences for delinquent borrowers or even borrowers who do not fully understand the program. Accordingly, with loan programs such as home equity loans and reverse mortgages increasing in popularity, borrowers should be familiar with equity and the consequences of borrowing against home equity.
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