Home equity example

Written by Anytime EstimateOctober 21st, 20214 minute read

Some individuals are perplexed by the phrase "home equity." So, to understand home equity loans, let's look at a few examples.

You most likely put a down payment on your house when you bought it. The down payment might have been as little as 3% or as much as 20% or more.

Let's assume you paid $100,000 for the house and put down 5% ($5,000) on it, with a 6% interest rate for a 30-year period.

In this case, your "home equity" would be as follows:
5% home equity

You have 5% ownership in the home or 5% “equity” ($5,000). The bank owns 95% of the home. After a few years of making mortgage payments, your “equity (ownership) grows to approximately $11,598.36 ($5,000 down payment + $6,598.36 additional equity from paying down on the mortgage).

10% home equity

But after 5 years, not only did you reduce the amount that you owe the bank, but the house has increased in value (hopefully). The home may now be worth $110,000. So the equity in the home is the down payment ($5,000) plus the amount you paid down on the mortgage ($6,598.36) plus the increase in value ($10,000).

Down payment = $5,000
Mortgage payments = $6,598
Increase in value = $10,000
Your Total Equity = $21,598

Home equity in the house

The home equity is the difference between the current home value, less the balance of the mortgage, if any.

Current value = $110,000
Less mortgage balance = $88,401.64
Your Total Equity = $21,598

Now that you know what the term home equity is, let’s learn about equity loans. A home equity loan is a loan against the amount of equity that is available. In the previous example, the homeowner had achieved $21,598 equity (or ownership) after 5 years.

After owning a home for some period of time, homeowners need money for home improvements, unforeseen expenses, or find that a home equity loan is a good way to consolidate credit card debt. Here’s how a home equity loan works . . .

The home equity loan requirements vary from lender to lender and from state to state. Using the previous example, a bank might loan the homeowner half of the available equity in the home ($10,799). Most home equity lenders will only lend a percentage of the total equity. There a several reasons for not lending up to the total equity of the home. One reason is that the appraiser or value estimator could overvalue the property. Another reason, and the most important reason, is that if the bank would have to foreclose on the homeowner, the bank can sell the home for less than the total value of the home (Sales price less the balance of the first mortgage and home equity loan).

What is the difference between a home equity loan and a home equity line of credit?

A home equity loan gives you the money you need in the form of a lump sum payment with a set interest rate.

A home equity line of credit (HELOC) enables you to borrow or draw money on a monthly basis for a predetermined amount.

In contrast to home equity loans, HELOCs (home equity lines of credit) often have variable interest rates.

If you're having trouble paying your mortgage payments, first consult with a housing consultant to determine if there are any other options that make more financial sense for you.

SOURCE:Consumer Financial Protection Bureau (CFPB)

Rotating question markHome Equity Loans: Frequently Asked Questions

Q: Are home equity loans a smart investment?
A. For many homeowners, home equity loans are a smart choice. Home equity loans can be utilized to consolidate debt.

Paying down credit-card debt with a home equity loan can frequently result in a cheaper overall credit card monthly payment(s) since the total credit card debt can be stretched out over a longer duration and at a lower interest rate with a home equity loan.

Home equity loan interest rates are often lower than credit card interest rates. Banks can provide a lower interest rate on a home equity loan, since the homeowner is putting up the house as security. If the homeowner fails to make the home equity payment, the bank may sell the house by foreclosing.

Q. Is it possible to refinance home equity loans?
A. Home equity loans can be refinanced if there is enough equity.

Q. Can you borrow money with a home equity loan at any time?
A. With a line of credit (home equity loan), you can draw from it in the same way that you would with a credit card.

Q. Can a home equity loan be utilized to make a down payment on a house?
A down payment can be made via a home equity loan (or a home-equity line of credit).

Remember that the additional payment will be factored into your debt-to-income computation.

Q. Can I receive a home equity loan if I recently purchased a property?
A. You can get a home equity loan or a home equity line of credit if you have enough equity, which is usually at least 15% of the property's market value.

Q. Is an appraisal required for a home equity loan?
A. Lenders will want an appraisal.

After all, without an appraisal, how can a lender decide the loan amount?

Q. Is it possible to get a home equity loan with no payments?
A reverse mortgage can provide a variety of lending choices that do not require a monthly payment.