No, it’s your “equity” meaning whatever the house sells (or would sell) for, if it’s over the principal amount, you get to keep it. Your equity goes up by (a) paying down your principal, and/or (b) your house increasing in market value.
For example, since equity is defined as (mkt_value - loan_balance), if your house’s market value is (say) 100,000 where you still owe 87,000, then your “home equity” is 17,000, since if you couldn’t keep up with mortgage payments and had to sell your house, you would actually have 17,000 left after the bank takes what is due them.
Of course the “true market value” of your house is not known until a sale is actually closed – what’s usually given as a baseline for home equity loans and the like is the “expected value” of your house based on what other similar homes in your neighborhood have gone for in recent months.
That’s why home equity loans are a somewhat dangerous thing; the lender is basically refinancing your mortgage, lending you more money based on a “marked to market” valuation of your home, which if done in a highly volatile area or time (in other words, if you are on the wrong side of a “housing bubble”), you could well end up eating in a crunch.
That’s also why second position loans are always at a higher interest rate (and usually adjustable as opposed to fixed.) In a foreclosure, the primary lender gets paid off first, and whatever is left over goes to the secondary guy. Being in the second position is therefore much riskier, so they charge more interest.
Your point is correct on one level but but flawed on the larger level.
The banks are not happy. Foreclosure is a PITA for eveyone involved. Banks do not want to foreclose, they want to suck interest payments out of whoever owes the money. They lend the money intending to make a profit, not to own liens on property. Typically, there is no profit in foreclosure. There are mortgage companies and banks that are scared as hell today because the loans that they bet on are falling into foreclosure at a higher rate than what they predicted when they made the loans.
The market fell over 400 points today. This could foreshadow a lot of problems. If defaults on a lot of the home equity loans that looked so attractive a few years ago go sour, then Katie bar the door!
Pretty simple. You own your house subject to the mortgage you gave the bank in exchange for the loan to buy it. (A mortgage is a lien granted by you to them to induce them to make you a loan – that gets confusing, because most people equate it with the loan it’s the collateral for.) You made a down payment, say $15,000, and you’ve been paying off that loan for several years, say five. Say each payment was $150, and $70 went for interest and $80 towards principal – that’s 5 years x 12 monthly payments of $80 = $4,800 paid towards principal. Your house meanwhile has appreciated several thousand since you bought it, and now would list for $160,000. If you inherited several million from your rich uncle and paid off the loan today, there’d be a number that constituted the outstanding principal – let’s say $118,000. The difference between the $160,000 your house is worth and the $118,000 principal still due on the loan, or $42,000, is your equity in the house. If you sold it tomorrow for list price and of course paid off the loan, that’s what you’d be entitled to (less, of course, fees for all the helpful moneygrubbers involved in the deal).
Because that’s what your share, as opposed to the bank’s share, of the house’s value is worth, it’s an asset you can now use as collateral for a Home Equity Line of Credit (HELOC). The problem is that people don’t realize that HELOCs are for all practical purposes higher-rate mortgage loans, giving you money at the cost of your interest in your own home.
Banks and other mortgage investors hate foreclosures because:
They lose income on the loan. And they’ve typically paid out money to get the loan in the first place. If you got your loan through a mortgage broker, it probably got paid front end points–by you, and some points on the back end (paid by the loan originator) 3 points on the back means the investor funds the loan *and * pays the broker 3 percent of the loan amount to boot. That means the investor bought the mortgage at 103% of its face value. If the loan defaults early, the investor is already losing money. (Believe it or not, this is a vast oversimplification–I’m not even going into secondary marketing).
They often have to wait a long time to get the property back (see my first link above). In the interim, they’ve got to shell out money to force-place insurance, at least.
People who are in foreclosure often don’t give a crap about the property and don’t maintain it. Some are genuinely mad at the world, or the bank, or whatever, and take fixtures and anything else they can or even sabotage the property. (I heard a story one about a rural property where the mortgagor took a half-acre of trees with him.)
Once they get it back, they’ve got to maintain the property, keep it insured, and sell it. All of these cost money.
This is why it’s harder and more expensive to get 100% financing. If an early default occurs, the investor loses big time. They are starting out with the pipe dream that they’ll be able to turn the property over quickly for the amount they lent against it. Even if that fantasy works out, their investment was a total loser. They’ve paid out a premium and probably can’t recover it. Again, it’s a lot more complicated, but that’s the general idea.
These costs are all supposedly reflected in fees and interest rates. Nevertheless, this concept gets neglected when the investor is analyzing the performance of an individual loan.
The conversation seems to have covered most of the equity info. Just thought I’d toss out this additional point to ponder. Say you have your $60k house with a $43k mortgage. You get a job in another state and need to sell. Someone offers you $60k. Cool. You’ve got $17k to start all over. Except you most likely have to pay the realtor who sells your house, usually 6% of the sale cost, and there will be some other fees there too. So your $60k sale gets you maybe $56k minus the $43k mortgage, and you really pocket $13k.
If you’ve been in your house for several years, and paid down the debit on it or had the house value increase, that’s not a huge deal. If you’ve only been in your house a couple of years, the cost of selling your house could eat up any equity you have. That’s the reason to consider not buying a house if you are going to move in a short time.
This is excellent advice. I’m under the impression that you’re still in college. I’d advise not buying until you’ve found an area that you are willing to live in for at least 6 or 8 years, in order to ride out any depreciation in the market. Remember, in California, the early 1990’s saw a decline of home values on the order of 25% or more. Don’t let the ridiculous appreciation of California real estate over the past 5 years skew your expectations.
The other notable bit of information is that you can avoid capital gain taxes by rolling over the proceeds of the sale of your house into an equivalently or more expensively priced home if you purchase it within a certain amount of time (2 years?).
I find it charming that we are using examples of $60,000 houses. You do live in Irvine, right (or heaven forbid, Balboa Island!)?
The rules for capital gains on house sales changed quite a while ago. The current rule is that $250,000 of your gain (or $500,000 if married filing jointly) is exempt from capital gains tax if you have lived in the house as your primary residence for two of the last five years. You don’t have to roll the proceeds over to take advantage of the exemption.
Oooh, I want to glom onto this thread and ask about my (possible) situation:
Say I have $15k equity in the home I own now and I need to buy a house in another state for a new job. The market where I’m selling is very slow, but I gotta have somewhere to live in New Job State and I’m cash poor.
The best case scenario seems to be that I have enough cash to move and put a down on another place (or make a rent-to-own/bridging agreement); worst case is that I’m stuck with two mortgages and/or House in Old State doesn’t sell for enough to cover mortgage *and * equity loan . . right?
Right. But this is a pretty bad combo. If you have to do a short sale or deed the property back to the mortgagee, it’ll hurt your credit. If you had enough cash to pay any shortfall, then it would still be a bad situation, but not *as * bad.
The first link (Detroit Local News - Michigan News - Breaking News - detroitnews.com) that I posted is an article from yesterday’s Detroit News discussing the surge in deeds in lieu of foreclosure and short sales because of the stagnant real estate market here. You want to avoid either of those things if you can.
OTOH, if you’ve got to move, you don’t have a lot of other options.
As a side not to many of the otherwise excellent posts, capital gains taxes can create an ugly shift in the profitability of a home sale, consult a tax pro/CPA before considering any kind of low equity real estate sale. I have a place up for sale that if not sold by 04/08 I will be on the hook for about $20K in taxes at sale.
Emphasis mine. I see this kind of claim all the time with respect to falling housing prices. I’m amazed that anyone can say with a straight face that the home is worth about $180K when they’ve gotten no offers on an asking price of $180K for three months. And it’s not like someone’s going to up and offer the asking price any time soon.
There’s definitely something to it: “a reasonable time is allowed for exposure in the open market” is part of the typical definition of “market value” as it is applied to real estate.
“Reasonable time” is not an explicitly defined term, and depends on the property type in question as well as what’s typical in the market in which it is located. It’s up to the appraiser to define what a “reasonable” exposure time is for the real estate he’s appraising. A typical house in a typical neighborhood obviously has a shorter “reasonable” exposure time than a 900,000 square foot cold storage facility in the middle of Montana. But my understanding is that 30 to 90 days is generally considered typical for a house, so you’re right, 3 months is probably not all that long for that market (but I don’t know since I don’t know that market).
But if you put a house on the market for say $250,000, it’s pretty typical and in a pretty typical neighborhood, and it sits there for a year while plenty of other similar houses around it are selling (especially if for less money) then you’ve probably got pretty good evidence that your market value ain’t $250,000.
Conversely, if you’re a highly motivated seller and need to sell in a hurry (say, faster than normal in your area) and list it for, I dunno, half of what other typical houses in the area sell for, you’re also violating the typical definition of market value and just because you sell it for $90,000 doesn’t mean that’s the market value, if you could have gotten $180,000 by marketing it in a typical manner for a few weeks or a month or so (whatever is typical in your market).