Home equity
Encyclopedia
Home equity is the market value
of a homeowner's unencumbered
interest in their real property
—that is, the difference between the home's fair market value
and the outstanding balance of all lien
s on the property. The property's equity
increases as the debtor makes payments against the mortgage
balance, and/or as the property value appreciates
. In economics
, home equity is sometimes called real property value.
Technically, home equity has a zero rate of return
and is not liquid
. Home equity management refers to the process of using equity extraction
via loan
s—at favorable, and often tax-favored, interest rate
s—to invest otherwise illiquid
equity in a target that offers higher returns.
Home owners acquire equity in their home from two sources. They purchase equity with their down payment, and the principal portion of any payments they make against their mortgage. They also benefit from a gain in equity when the value of the property increases. Investors typically look to purchase properties that will grow in value, causing the equity in the property to increase, thus providing a return on their investment when the property is sold.
Home equity may serve as collateral
for a home equity loan
or home equity line of credit
(HELOC). Many home equity plans set a fixed period during which the person can borrow money, such as 10 years. At the end of this “draw period,” the person may be allowed to renew the credit line. If the plan does not allow renewals, the person will not be able to borrow additional money once the period has ended. Some plans may call for payment in full of any outstanding balance at the end of the period. Others may allow repayment over a fixed period, for example, 10 years.
Market value
Market value is the price at which an asset would trade in a competitive auction setting. Market value is often used interchangeably with open market value, fair value or fair market value, although these terms have distinct definitions in different standards, and may differ in some...
of a homeowner's unencumbered
Encumbrance
Encumbrance is legal technical terminology for anything that affects or limits the title of a property, such as mortgages, leases, easements, liens, or restrictions. Also, those considered as potentially making the title defeasible are encumbrances...
interest in their real property
Real property
In English Common Law, real property, real estate, realty, or immovable property is any subset of land that has been legally defined and the improvements to it made by human efforts: any buildings, machinery, wells, dams, ponds, mines, canals, roads, various property rights, and so forth...
—that is, the difference between the home's fair market value
Fair market value
Fair market value is an estimate of the market value of a property, based on what a knowledgeable, willing, and unpressured buyer would probably pay to a knowledgeable, willing, and unpressured seller in the market. An estimate of fair market value may be founded either on precedent or...
and the outstanding balance of all lien
Lien
In law, a lien is a form of security interest granted over an item of property to secure the payment of a debt or performance of some other obligation...
s on the property. The property's equity
Ownership equity
In accounting and finance, equity is the residual claim or interest of the most junior class of investors in assets, after all liabilities are paid. If liability exceeds assets, negative equity exists...
increases as the debtor makes payments against the mortgage
Mortgage loan
A mortgage loan is a loan secured by real property through the use of a mortgage note which evidences the existence of the loan and the encumbrance of that realty through the granting of a mortgage which secures the loan...
balance, and/or as the property value appreciates
Appreciation
In accounting, appreciation of an asset is an increase in its value. In this sense it is the reverse of depreciation, which measures the fall in value of assets over their normal life-time...
. In economics
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
, home equity is sometimes called real property value.
Technically, home equity has a zero rate of return
Rate of return
In finance, rate of return , also known as return on investment , rate of profit or sometimes just return, is the ratio of money gained or lost on an investment relative to the amount of money invested. The amount of money gained or lost may be referred to as interest, profit/loss, gain/loss, or...
and is not liquid
Market liquidity
In business, economics or investment, market liquidity is an asset's ability to be sold without causing a significant movement in the price and with minimum loss of value...
. Home equity management refers to the process of using equity extraction
Mortgage equity withdrawal
In economics, mortgage equity withdrawal is the decision of consumers to borrow money against the real value of their houses. The real value is the current value of the property less any accumulated liabilities Some authors also use equity extraction and include net payments received at time of...
via loan
Loan
A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower....
s—at favorable, and often tax-favored, interest rate
Interest rate
An interest rate is the rate at which interest is paid by a borrower for the use of money that they borrow from a lender. For example, a small company borrows capital from a bank to buy new assets for their business, and in return the lender receives interest at a predetermined interest rate for...
s—to invest otherwise illiquid
Market liquidity
In business, economics or investment, market liquidity is an asset's ability to be sold without causing a significant movement in the price and with minimum loss of value...
equity in a target that offers higher returns.
Home owners acquire equity in their home from two sources. They purchase equity with their down payment, and the principal portion of any payments they make against their mortgage. They also benefit from a gain in equity when the value of the property increases. Investors typically look to purchase properties that will grow in value, causing the equity in the property to increase, thus providing a return on their investment when the property is sold.
Home equity may serve as collateral
Collateral (finance)
In lending agreements, collateral is a borrower's pledge of specific property to a lender, to secure repayment of a loan.The collateral serves as protection for a lender against a borrower's default - that is, any borrower failing to pay the principal and interest under the terms of a loan obligation...
for a home equity loan
Home equity loan
A home equity loan is a type of loan in which the borrower uses the equity in their home as collateral. These loans are useful to finance major expenses such as home repairs, medical bills or college education...
or home equity line of credit
HELOC
A home equity line of credit is a loan in which the lender agrees to lend a maximum amount within an agreed period , where the collateral is the borrower's equity in his/her house...
(HELOC). Many home equity plans set a fixed period during which the person can borrow money, such as 10 years. At the end of this “draw period,” the person may be allowed to renew the credit line. If the plan does not allow renewals, the person will not be able to borrow additional money once the period has ended. Some plans may call for payment in full of any outstanding balance at the end of the period. Others may allow repayment over a fixed period, for example, 10 years.