Mortgage Advice
Mortgages

Understanding Mortgages: What is Equity?

(07/24/2012) In the midst of one of the most uncertain real estate markets in history, it’s more important than ever to be informed. In a continuing series, we take a look at some of the most pressing questions about mortgages, refinancing, home equity, and other real estate options available to you.

Over the last few years, as news outlets reporting on the housing collapse provided new statistics and assessments of the market, equity was a key term in the discussion. Whether looking at “underwater” borrowers, delinquency, foreclosure, and other key figures, equity plays into it all.

Equity is the current market value of a home, minus the outstanding mortgage balance. As an example - if a home is worth $200,000, and borrowers still owe $125,000, the equity accrued is $75,000.

In a perfect housing world, borrowers use a mortgage to purchase a home. Over the 15 or 30 years of the mortgage term, the owners gradually build up equity. Once the term is done, and the loan is completely paid, the owners have complete equity in the property, and complete ownership.

However, in the less than perfect housing world of recent months and years, borrowers have seen their home values plummet, while their mortgage amounts stay the same. The result is negative equity, where owners owe more than their home is worth. This is also called “underwater.” In many cases, the state of being underwater has caused borrowers to default on their mortgages. This has led to a spike in short sale and foreclosures.

When homeowners can still maintain and build equity in their homes, there is the benefit of accrued ownership. But there are also additional options available to them for financing.

Home equity loans borrow against the equity built in the home. Borrowers can use home equity loans to consolidate other debt (like credit card debt), finance large expenses (like college tuition), or to purchase other big-ticket items (like home remodeling items). Interest on home equity loans is deductible, resulting in significant tax savings.

Traditional home equity loans are often called “second mortgages,” and provide a lump sum paid back over a fixed period. Another option is a home equity line of credit that works like a checking account or credit card.