What are home equity loans?
Home equity loans are borrowing money against the equity that you have in your home. This is also known as a second mortgage. The formula for calculating home equity is pretty straightforward, home equity is just gonna be equal to the fair market value of your home and then you subtract out the remaining balance due on your mortgage.
Example of home equity loans
Let’s say that the fair market value of your home is $140,000. The principal remaining on your mortgage is $25,000. So now that means that you have $115,000 in equity in your home.
Now you can use your share in the home as collateral to get a second mortgage. You can now borrow against this and there are a couple different ways that you can do it.
- Fixed Rate Loan (Home equity loan)
- Home Equity Line of Credit (HELOC)
How much can I borrow?
In our example, before we said well we have $115,000 in home equity does that mean that I can go and borrow $115,000 from the bank on a second mortgage?
Well not necessarily. Every bank does things differently but I’m just gonna give you kind of an idea of how a bank might go about calculating the maximum you could get for a home equity loan.
First off you start out with the fair market value of the home and then the bank is gonna have some kind of percentage rate let’s say it’s 75% for this example. The house is worth $140,000, and we would be able to lend up to 75% of that value after deducting the first mortgage that still has yet to be paid.
So you take 75% of the fair market value of the home and that’s $105,000 and then you deduct out whatever happens to be the remaining balance on the first mortgage which was $25,000 in this example. So that comes out in this example to $80,000.
Things to remember
Here’s an important thing to remember when you do a home equity loan that’s you’re giving up equity. I see you’ve spent a long time building up equity in your home and now you’re borrowing this $80,000 against that equity. So now you don’t have that equity because you just borrowed against it and if you don’t make payments on your home equity loan, you could lose your home.