What is A Home Equity?
The difference between the market value of your real estate property and the mortgage you have on your real estate property.
For example, suppose the market value of your property is $500,000 and you have a loan of $300,000 against it. Then, the equity position in this example is $500,000 – $300,000 = $200,000.
What is A Home Equity Loan?
A home equity loan is a loan you take against the equity you have in your home. It is also known as the ‘second mortgage’.
How To Calculate Your Equity?
This is where most of the investors get a bit confused. There are certain things you need to keep in mind while calculating your equity.
Let us explain this first with the help of an example:
Here, you have a real estate property whose market value is $500,000. In That, you owe $300,000.
Now, let’s find out how much equity is accessible to you:
If you access $100,000 worth of equity, the total borrowings will be $400,000 ($300,000 + $100,000). This also represents the 80% of the entire market value of the property.
This is very important to understand that at this point, you don’t have to account for the Lender’s Mortgage Insurance. As long as your total borrowing is under 80% loan to value ratio, you don’t have to pay the LMI.
Another $50,000 can be accessed from your equity but for that, you’ll have to pay for the LMI. Since the total borrowing is now 90% of the market value, additional insurance is required.
An important point here to note is that the LMI will not only be charged on the additional $50,000 but will be on the entire $450,000. This can get really costly sometimes. However, some people take the loan against additional equity too. This is done because the returns on investment just might outweigh the LMI cost.
Can I Access The Entire 100% of The Property Market Value in Equity?
This is where most of us make a mistake. No, you can’t access the remaining 10% of the equity. It will be only accessed if you decide to sell the property. In previous days, lenders used to let you borrow on the 100% of your home’s market value. However, now there is a cap of 90% market value.
How To Access The Home Equity Loan?
The home equity loan is of two types:
- Lump Sum Payout
- Line of Credit
A lump sum payout is a one-time payment for your accessible equity which directly gets deposited into your bank account, or you will get a cheque. This is a one-time settlement.
As opposed to withdrawing all the funds at once, a line of credit enables you to take a few at a time, pay the interest on just that, and continue. This gives you more flexibility in terms of your money investment plans.
Lump Sum Payout or Line of Credit?
Also known as “The Loan”, the lump sum payout is advised only if you want to invest the entire money at once, or in needs of emergencies where a large amount of money is required. If you want to pay a loan fast, you can consider this in case the interest rates suit you. Also, investments in properties can also be done with lump sum home equity loans. You have to start calculating the interest on the entire amount from the very starting.
Also known as “The Line”, the line of credit enables you to withdraw only a part of the accessible home equity. This stands helpful when you don’t need a large amount of money and saves you from paying the interest on the entire loan. This can be used to pay the credit card bills, pay for home renovations, and many other activities. You’ll just have to pay the interests on the loans you have drawn from the line of credits.