# How does home equity work? **URL:** \ **Category:** Factual Questions\ **Created:** [March 26, 2004, 5:41am UTC](https://boards.straightdope.com/t/how-does-home-equity-work/236518 "2004-03-26T05:41:16Z")\ **Posts on this page:** 20\ **Page:** 1
**Author:** ![Frylock](https://avatars.discourse-cdn.com/v4/letter/f/ce7236/32.png) [@Frylock](https://boards.straightdope.com/u/Frylock)\ **Post date:** [March 26, 2004, 5:41am UTC](https://boards.straightdope.com/t/how-does-home-equity-work/236518/1 "2004-03-26T05:41:16Z")
Anyone here care to explain in simple terms how the whole home equity thing works? I keep hearing about it but still have no idea exactly what it is. -FrL- ---
**Author:** ![Enola\_Straight](https://avatars.discourse-cdn.com/v4/letter/e/dec6dc/32.png) [@Enola\_Straight](https://boards.straightdope.com/u/Enola_Straight)\ **Post date:** [March 26, 2004, 5:46am UTC](https://boards.straightdope.com/t/how-does-home-equity-work/236518/2 "2004-03-26T05:46:08Z")
> [@Frylock](#): > > Anyone here care to explain in simple terms how the whole home equity thing works? I keep hearing about it but still have no idea exactly what it is. > > -FrL- It means the part of your real estate you own…the part not owned by the bank in the form of a mortgage. Lets suppose you paid into a mortgage for a few years and have invested a fet tens or thousands of dollars…that is an asset; collateral for which you can borrow against when taking out a loan. ---
**Author:** ![Enola\_Straight](https://avatars.discourse-cdn.com/v4/letter/e/dec6dc/32.png) [@Enola\_Straight](https://boards.straightdope.com/u/Enola_Straight)\ **Post date:** [March 26, 2004, 5:49am UTC](https://boards.straightdope.com/t/how-does-home-equity-work/236518/3 "2004-03-26T05:49:03Z")
> [@Enola Straight](#): > > It means the part of your real estate you own…the part not owned by the bank in the form of a mortgage. > > Lets suppose you paid into a mortgage for a few years and have invested a fet tens or thousands of dollars…that is an asset; collateral for which you can borrow against when taking out a loan. Make that “a few tens or hundreds of thousands of dollars.” ---
**Author:** ![Earl\_Snake-Hips\_Tucker](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/earl_snake-hips_tucker/32/3269_2.png) [@Earl\_Snake-Hips\_Tucker](https://boards.straightdope.com/u/Earl_Snake-Hips_Tucker)\ **Post date:** [March 26, 2004, 5:53am UTC](https://boards.straightdope.com/t/how-does-home-equity-work/236518/4 "2004-03-26T05:53:52Z")
Basically, Home Equity = Market Value - Loan Principal Amount ---
**Author:** ![friedo](https://avatars.discourse-cdn.com/v4/letter/f/8edcca/32.png) [@friedo](https://boards.straightdope.com/u/friedo)\ **Post date:** [March 26, 2004, 6:51am UTC](https://boards.straightdope.com/t/how-does-home-equity-work/236518/5 "2004-03-26T06:51:49Z")
> [@Earl Snake-Hips Tucker](#): > > Basically, Home Equity = Market Value - Loan Principal Amount To be clear, that’s - _Remaining_ Loan Principal Amount. ---
**Author:** ![One\_And\_Only\_Wanderers](https://avatars.discourse-cdn.com/v4/letter/o/838e76/32.png) [@One\_And\_Only\_Wanderers](https://boards.straightdope.com/u/One_And_Only_Wanderers)\ **Post date:** [March 26, 2004, 9:21am UTC](https://boards.straightdope.com/t/how-does-home-equity-work/236518/6 "2004-03-26T09:21:04Z")
buy a house for 50K. in ten years you still owe say 43 k, and if the house is now valued at 60K then you have 17K equity. If however the market has crashed and the house is only worth 40k in the same 10 years, then you are in a negative equity position to the tune of 3K ---
**Author:** ![Frylock](https://avatars.discourse-cdn.com/v4/letter/f/ce7236/32.png) [@Frylock](https://boards.straightdope.com/u/Frylock)\ **Post date:** [February 28, 2007, 3:01am UTC](https://boards.straightdope.com/t/how-does-home-equity-work/236518/7 "2007-02-28T03:01:33Z")
[QUOTE=One And Only Wanderers] buy a house for 50K. in ten years you still owe say 43 k, and if the house is now valued at 60K then you have 17K equity. If however the market has crashed and the house is only worth 40k in the same 10 years, then you are in a negative equity position to the tune of 3K [/QUOTE] I’m resurrecting this thread because I originally started it and I had sat down to the computer to ask the very same question again. I’m glad I did a search first. Anyway, I want to ask a follow up. So, as per the last example, say I have 17k equity. What can I do with it? Someone said I can use it as collateral for a loan. What does that mean? How can it be collateral if its not something I actually have sitting around to surrender if need be? Here’s why this comes up. My friends and I are going to all start buying houses in a few years. Every now and then we all have “whistling in the dark” type conversations about our respective futures. In our line of work, its likely we are all going to have to move once or twice post graduation before we finally can settle down. So sometimes someone will say something like “I don’t know if I should buy a house right off, since I don’t know if I’m going to have to move or not.” Someone else will say, though, “Oh, you don’t have to worry about that, because: Equity.” Then everyone wil nod wisely and the conversation will turn to soe other topic. Except I get the feeling none of us actually knows what this means. Does having equity somehow make it safe(r) to move in the middle of trying to pay off a mortgage? If so, how? If not, why do people have this notion? -FrL- ---
**Author:** ![Fear\_Itself](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/fear_itself/32/19637_2.png) [@Fear\_Itself](https://boards.straightdope.com/u/Fear_Itself)\ **Post date:** [February 28, 2007, 3:07am UTC](https://boards.straightdope.com/t/how-does-home-equity-work/236518/8 "2007-02-28T03:07:57Z")
[QUOTE=Frylock] How can it be collateral if its not something I actually have sitting around to surrender if need be? [/QUOTE] Sure you do. Ever hear of foreclosure? They take your house, and sell it, thus claiming your collateral. ---
**Author:** ![Frylock](https://avatars.discourse-cdn.com/v4/letter/f/ce7236/32.png) [@Frylock](https://boards.straightdope.com/u/Frylock)\ **Post date:** [February 28, 2007, 3:12am UTC](https://boards.straightdope.com/t/how-does-home-equity-work/236518/9 "2007-02-28T03:12:17Z")
[QUOTE=Fear Itself] Sure you do. Ever hear of foreclosure? They take your house, and sell it, thus claiming your collateral. [/QUOTE] But it was said earlier in this thread that the 17k is collateral. That is distinct from the house. -FrL- ---
**Author:** ![Fear\_Itself](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/fear_itself/32/19637_2.png) [@Fear\_Itself](https://boards.straightdope.com/u/Fear_Itself)\ **Post date:** [February 28, 2007, 3:14am UTC](https://boards.straightdope.com/t/how-does-home-equity-work/236518/10 "2007-02-28T03:14:32Z")
[QUOTE=Frylock] But it was said earlier in this thread that the 17k is collateral. That is distinct from the house. -FrL- [/QUOTE] The equity is in your house, it is not distinct from the house. ---
**Author:** ![friedo](https://avatars.discourse-cdn.com/v4/letter/f/8edcca/32.png) [@friedo](https://boards.straightdope.com/u/friedo)\ **Post date:** [February 28, 2007, 3:22am UTC](https://boards.straightdope.com/t/how-does-home-equity-work/236518/11 "2007-02-28T03:22:44Z")
[QUOTE=Frylock] So, as per the last example, say I have 17k equity. What can I do with it? Someone said I can use it as collateral for a loan. What does that mean? How can it be collateral if its not something I actually have sitting around to surrender if need be? [/quote] Think of it this way. Your equity is the amount of money you’d get if you sold your place and paid off the remaining principal of your mortgage. That’s an asset. If you take out a loan secured by the equity, and fail to pay, then you forfeit that asset. The lender will file a lien against the property, and when it gets sold, the money goes to them instead of you. > [@](#): > > Here’s why this comes up. My friends and I are going to all start buying houses in a few years. Every now and then we all have “whistling in the dark” type conversations about our respective futures. In our line of work, its likely we are all going to have to move once or twice post graduation before we finally can settle down. So sometimes someone will say something like “I don’t know if I should buy a house right off, since I don’t know if I’m going to have to move or not.” Someone else will say, though, “Oh, you don’t have to worry about that, because: Equity.” Then everyone wil nod wisely and the conversation will turn to soe other topic. > > Except I get the feeling none of us actually knows what this means. > > Does having equity somehow make it safe(r) to move in the middle of trying to pay off a mortgage? If so, how? If not, why do people have this notion? It’s always a little more difficult to move when you’re a homeowner, because you have to sell your house and buy a new one instead of just signing a lease for an apartment. What your friends probably mean, though, is that you can usually make a profit or break even when you do this. As a simple example, let’s say you take out a 30-year fixed-rate mortgage for $200,000 at 7% APR to buy a house, with a $40,000 cash down-payment. At the moment of purchase, your house is worth the $40,000 you paid plus the $200,000 the bank paid. Why is it worth $240,000? Because that’s how much you paid for it. You’ve got $40,000 equity in that house, and you owe $200,000. Skip ahead five years. After five years, assuming you made the minimum payments on your mortgage every month, you will have paid off $11,736.46 of the loan principal. (You also paid $68,099.54 in interest.) So now, you have at least $51,736.46 worth of equity in your house. Over the long term, most real-estate increases in value, especially if you take good care of it. So if you sell it, it will probably appraise for more than $240,000. Let’s say the appraiser says it’s now worth $260,000. Equity = current value - remaining loan principal, so your real equity is $260,000 - ( $200,000 - $11,736.46 ) = $71,736. Hooray for appreciation! If the appraiser is right and you sell the place for $260,000, then you’ll spend $188,263.54 to pay off the remaining principal of your mortgage and pocket the difference – that’s your equity. ---
**Author:** ![Monstre](https://avatars.discourse-cdn.com/v4/letter/m/e274bd/32.png) [@Monstre](https://boards.straightdope.com/u/Monstre)\ **Post date:** [February 28, 2007, 3:22am UTC](https://boards.straightdope.com/t/how-does-home-equity-work/236518/12 "2007-02-28T03:22:58Z")
It’s part of the house. If you own something worth, say, $1000… you could sell it and get that cash in hand. So it’s a material asset. Now, suppose you own half of it (because half is paid off, and half is still a debt you are paying off). Then you could sell it for $1000, pay off the $500 you owe, and have $500 left in hand. So the portion you had originally paid off was a material asset. That $500 is your “equity”, in terms of that theoretical “something” that you owned half of. Equity is essentially the amount of the house you actually own, because it’s principal you’ve paid off. Because you could sell the house for it’s market value, pay off the rest of your mortgage principal with it, and have roughly your equity amount left over (minus selling costs…) ---
**Author:** ![Frylock](https://avatars.discourse-cdn.com/v4/letter/f/ce7236/32.png) [@Frylock](https://boards.straightdope.com/u/Frylock)\ **Post date:** [February 28, 2007, 3:23am UTC](https://boards.straightdope.com/t/how-does-home-equity-work/236518/13 "2007-02-28T03:23:34Z")
[QUOTE=Fear Itself] The equity is in your house, it is not distinct from the house. [/QUOTE] Okay, so: I owe 43,000 on a 60,000 house. I’ve got 17k equity in it. I take out something called a “home equity loan” for 17k. I do not make any payments, and so the entity who loaned the money to me forecloses. This means they now have the power to effect a sale of my home? And what, they split the money, 17k to them, and the 43k (assuming they got the whole value) to the bank I’m buying the house from? Accurate? Another situation for my other question: Again, say I owe 43,000 on a 60,000 house. This means I have 17k equity in it. Say I need to move somewhere else, so I sell (or arrange to have sold, or what?) my house, getting, say, 60,000 for it. I pay off 43,000 and keep 17k, then put that 17k in my next house. Is that how it works? Is this why people are saying it can be safe to move in the middle of a mortgage because of equity? I know a lot of you are rolling your eyes 🙂 and wondering how people can not know about this stuff. But the truth is, I and a lot of other people have not yet had to deal with this kind of thing. You have to learn sometime. -FrL- ---
**Author:** ![Gfactor](https://avatars.discourse-cdn.com/v4/letter/g/9de053/32.png) [@Gfactor](https://boards.straightdope.com/u/Gfactor)\ **Post date:** [February 28, 2007, 3:23am UTC](https://boards.straightdope.com/t/how-does-home-equity-work/236518/14 "2007-02-28T03:23:51Z")
[QUOTE=Frylock] Does having equity somehow make it safe(r) to move in the middle of trying to pay off a mortgage? If so, how? If not, why do people have this notion? -FrL- [/QUOTE] It can, sure. For one thing, your drop dead price is lower. All you “need” to sell the property for is the balance of the current mortgage. Having equity means you can sell the property cheaply and quickly for one thing. Also, you can avoid this: [Detroit Local News - Michigan News - Breaking News - detroitnews.com](http://www.detnews.com/apps/pbcs.dll/article?AID=2007702270375) :eek: You can also take out a bridge loan or use an existing Home Equity Line of Credit (HELOC) to make a downpayment on the new house. [http://www.hgtv.com/hgtv/ah\_real\_estate\_mortgages/article/0,1801,HGTV\_3161\_2719226,00.html](http://www.hgtv.com/hgtv/ah_real_estate_mortgages/article/0,1801,HGTV_3161_2719226,00.html) > [@](#): > > How can it be collateral if its not something I actually have sitting around to surrender if need be? As \*\*Fear Itself \*\* notes, you do have it sitting around to surrender. You take out a second mortgage (also known as a home equity mortgage or a HELOC), pledging the portion of the value of the home that isn’t spoken for by the existing mortgage to the new lender. If you don’t pay, the junior lienholder forecloses, pays off the first mortgage, and hopes that property values haven’t dropped (or :eek: the appraisal it got for purposes of determining your equity wasn’t inflated). If there’s not enough money to go around, the junior lienholder loses–although sometimes they can pursue you for the difference. The same thing happens if you don’t pay the first mortgage: House is sold; proceeds pay off first mortgage; remainder pays of second mortgage; any surplus goes to the owner (a rarity, really); deficiency may or not be recoverable, depending on the jurisdiction. ---
**Author:** ![Frylock](https://avatars.discourse-cdn.com/v4/letter/f/ce7236/32.png) [@Frylock](https://boards.straightdope.com/u/Frylock)\ **Post date:** [February 28, 2007, 3:25am UTC](https://boards.straightdope.com/t/how-does-home-equity-work/236518/15 "2007-02-28T03:25:45Z")
And from posts subesequent to the one I was replying to, it looks like I’ve got it right. So my ignorance is officially successfully faught, I think. -FrL- ---
**Author:** ![Shagnasty](https://avatars.discourse-cdn.com/v4/letter/s/9dc877/32.png) [@Shagnasty](https://boards.straightdope.com/u/Shagnasty)\ **Post date:** [February 28, 2007, 3:28am UTC](https://boards.straightdope.com/t/how-does-home-equity-work/236518/16 "2007-02-28T03:28:09Z")
The concept of a home equity home is pretty straightforward in simple terms. You have a house that is worth more than your remaining mortgage. You can use the difference in value between what you owe and what the house is worth on the market to borrow money against that remaining value. If you don’t pay the home equity loan back on time, the bank can foreclose on your house to get its money. The house is always held as collateral even if the home equity loan is small. Banks are very willing to give them because most people don’t like losing their houses. ---
**Author:** ![robby](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/robby/32/11048_2.png) [@robby](https://boards.straightdope.com/u/robby)\ **Post date:** [February 28, 2007, 3:28am UTC](https://boards.straightdope.com/t/how-does-home-equity-work/236518/17 "2007-02-28T03:28:22Z")
[QUOTE=Frylock] But it was said earlier in this thread that the 17k is collateral. That is distinct from the house. -FrL- [/QUOTE] The $17K is just the difference between what your house is worth ($60K in the above example) minus what you owe your mortgage lender ($43K). That’s your equity. Lenders generally don’t want to lend you more than your equity, because they want to be able to get their money back if you default. They get their money back by forcing a foreclosure sale in the event of default. For example, if you take out a $17K home equity loan based on your $17K of equity, and you fail to pay the loan back, then the lender can force a foreclosure. The proceeds from the sale (hopefully at least $60K, as far as the lenders are concerned) will be used to pay off your main mortgage ($43K) as well as the home equity loan ($17K). The banks are happy, then, as they get their money back, but you have lost your house. This is the risk you take when you take a low-interest home equity loan to pay off high-interest credit card debt. If you fail to pay back your credit card lender, they can’t foreclose on your home. A home equity lender can foreclose on you, though, just like your mortgage lender can. ---
**Author:** ![garygnu](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/garygnu/32/2924_2.png) [@garygnu](https://boards.straightdope.com/u/garygnu)\ **Post date:** [February 28, 2007, 3:29am UTC](https://boards.straightdope.com/t/how-does-home-equity-work/236518/18 "2007-02-28T03:29:06Z")
The more equity you have in the house, the more leeway you have in moving before paying off a mortgage because you end up with more cash in-hand upon selling. It’s hard to compare this to sitting on cash while renting, but cash is more liquid than equity, though. That $17k in equity from the example can be effectively “sold” to a bank (in whole or in part)for cash. This is a home-equity loan. Think of it as having $60k worth of collateral with only a $43k loan, you still have 17k worth of collateral, even though it is the same source as the $43k. (Hmmm… on preview… oh hell, I’ll post it anyway.) ---
**Author:** ![Gfactor](https://avatars.discourse-cdn.com/v4/letter/g/9de053/32.png) [@Gfactor](https://boards.straightdope.com/u/Gfactor)\ **Post date:** [February 28, 2007, 3:30am UTC](https://boards.straightdope.com/t/how-does-home-equity-work/236518/19 "2007-02-28T03:30:28Z")
[QUOTE=Frylock] Okay, so: I owe 43,000 on a 60,000 house. I’ve got 17k equity in it. I take out something called a “home equity loan” for 17k. I do not make any payments, and so the entity who loaned the money to me forecloses. This means they now have the power to effect a sale of my home? [/QUOTE] In most cases, yes. > [@](#): > > And what, they split the money, 17k to them, and the 43k (assuming they got the whole value) to the bank I’m buying the house from? Accurate? Basically, except you aren’t “buying the house.” You have what we call secured debt. You owe a creditor money, and you’ve given them an interest in your property as a means of securing payment. Foreclosure is how they convert their security interest into money. > [@](#): > > Another situation for my other question: Again, say I owe 43,000 on a 60,000 house. This means I have 17k equity in it. Say I need to move somewhere else, so I sell (or arrange to have sold, or what?) See my links. Sell or arrange makes no difference. Qualifying for the new mortgage will be easier with equity if there is a gap period where you will have two mortgages. > [@](#): > > I pay off 43,000 and keep 17k, then put that 17k in my next house. Is that how it works? Bingo. > [@](#): > > Is this why people are saying it can be safe to move in the middle of a mortgage because of equity? See my links and previous comments. ---
**Author:** ![robby](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/robby/32/11048_2.png) [@robby](https://boards.straightdope.com/u/robby)\ **Post date:** [February 28, 2007, 3:32am UTC](https://boards.straightdope.com/t/how-does-home-equity-work/236518/20 "2007-02-28T03:32:16Z")
Geez, I type out a reply, and fifteen other posts show up in the meantime? :smack: [Next page](https://boards.straightdope.com/t/how-does-home-equity-work/236518.md?page=2)