November 13, 2018
Lisa and Tom purchased a home for $130,000 and made a down payment of $50,000. They took out a home loan, or mortgage, with their credit union for $80,000. The amount of the home that they “own” is $50,000. Of course, the rest is what they owe.
In financial terms, they have $50,000 in equity.
Six months later, Lisa decides to start a small business and figures they can borrow money on their house, maybe even up to the $50,000 they put into it. They order an appraisal and find that the value of their home has now gone up to $150,000. Both Tom and Lisa were thrilled with this discovery because now they have $70,000 in equity and can use that to help them borrow for the new business.
Many home owners choose to borrow against that equity for a variety of reasons, such as home improvements, weddings, vacations, educational expenses, etc. This is called a home equity loan.
Such home equity loans have other advantages, too. The interest paid on a home equity loan is usually tax deductible. Home equity loans can feature fixed rates with fixed payments and terms, which are usually five to 15 years.
Equity is the difference between the market value of your home and the amount that you still owe on your mortgage. The equity in your home will increase as you pay your monthly payments. Of course, in the early years of your loan, most of your monthly payment goes towards paying off the interest owed to your lender. But, each month, a certain percentage also goes towards paying off your principal and this increases your equity in your home. Equity also goes up as the property increases in value.
RELATED: Fixed-Rate Home Equity Loan
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