Most”homeowners” don’t have their homes outright. They borrowed money to buy them and as long as they’re still paying the mortgage off, they’re co-owners of the property with their lender. The homeowner’s talk of the house is called”equity.” In other words, equity is the difference between what your house is worth and what you owe on it.
There are lots of methods to build home equity. The first is using a down payment. Say you’re buying a $400,000 house. Many lenders require buyers to make a down payment of 10 percent or 20% of the purchase price. This can be your first equity in the house. If you put down 10 percent, then you start out with $40,000 in equity. Your creditor writes you a 360,000 mortgage for the remainder. As soon as you’re at the house, you start making monthly payments on that mortgage. Some of each payment goes to repay the”principal,” the money that your lender gave you to purchase the house, and a few goes to pay attention. So each month, you gain a little more equity in the house.
After the market value of your home changes, it directly affects your equity–and only your equity. The amount you owe on your house doesn’t change, except as you repay the mortgage. By way of instance, if your $400,000 house suddenly shot up to $420,000 in worth the day after you purchased it, that additional $20,000 would go straight to your equity. You own $60,000 value of the house, and you’d still owe $360,000 to the lending company. But if the value of the house dropped to $380,000, that $20,000 would come straight out of your equity. You would now have only $20,000 value of your home –but you’d owe the same $360,000.
In case your house dropped $50,000 in value the day after you purchased it, then you would be in a really unpleasant situation. You would still owe $360,000 on the home –but the house is worth only $350,000. You now owe over your house is worth. This is called”negative equity”–or, colloquially, being”under water” to a house.
It is important to keep in mind that home equity doesn’t become”real” until you really sell your home, pay off what’s left of your mortgage with the money you get from the purchaser, and pocket the restof the As long as you are still in the home, your equity is present only on paper. But you can borrow against that equity by taking out a home equity loan, even starting a home equity line of credit or performing a”cash-out refinance.”
When financial institutions use phrases such as”tap the equity in your home,” it’s tempting to think about increases in home equity as earnings. And, really, as house prices rose rapidly in the early 2000s, countless people treated their dramatic equity gains as if they were earnings, carrying out loans to convert equity into cash and then spending it. Nevertheless, it was not income; it had been debt. When house prices collapsed starting in 2006, many of these homeowners wound up deep under water. The money was gone, but the debt remained.