Mortgages Analyzed
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Home Equity

What is Home Equity?

Home Equity

Home Equity is the amount of homeowner's investment in a real estate. It is the difference between the fair market value of the property and the outstanding balance for all the loans against the property.

At the time of purchase, the home equity equals the difference between the property value and total of mortgage loans. At this time, property value is the lower of appraised value and the purchase price. At any other time, such as during refinance, home equity equals the difference between the fair market value and the outstanding principal balance of all mortgage loans against the property. Appraised value is generally used as the fair market value.

Home equity changes due to two factors:

  1. Change in Loan Amount: Each month when a borrower makes a payment, the home equity increase by the portion of the payment that was applied towards the principal loan amount. On the other hand, when the borrower takes additional loans, such as HELOC’s or cash-out refinance, then the home equity goes down. Pay Option ARMs where the minimum payment results in negative amortization would also cause a reduction in home equity when the borrower makes only the minimum payment.
  2. Change in Property Value: Increase in property value will increase the home equity. On the other hand, a decline in property value will decrease the home equity. In some cases the decline in property value can be so large that it may totally wipe out the home equity or even cause it to be negative. A mortgage loan which has a negative equity is known as underwater mortgage. In other words, underwater mortgage is a mortgage loan where the outstanding principal balance is greater than the fair market value of the real estate that is used as the security for the loan.
Source :www.MortgagesAnalyzed.com

Home Equity may not be the same as down payment at the time of purchase

Property value, at purchase, is considered to be the lower of purchase price and appraised value. Purchase price that is in excess of the appraised value is the premium that the homeowner is paying at the time of purchase. When there is a premium, the home equity will not be the same as down payment. This is because home equity is difference between property value and the sum of all mortgage loans. On the other hand, down payment is the difference between purchase price and the sum of all mortgage loans. Therefore, the difference between the home equity and down payment is the premium amount that the homeowner is paying over the property value.

Purchase Premium = Appraised Value - Purchase Price = Home Equity – Down Payment

Formula for Home Equity

Home equity is the difference between the property value and total of mortgage loans. It can be expressed using the formula below.

Home Equity = Property Value - Sum of outstanding mortgage loans

Or,

Home Equity = PV - (UPB1 + UPB2 + UPB3 + ... + UPBk)

Rewritten as

Home Equity =   PV -
Σ UPBk

Where,

UPBk  =  Principal amount for loan k
PV  =  Property value (Lower of purchase price and appraised value)
n  =  number of loans
Source :www.MortgagesAnalyzed.com

Examples for Home Equity Calculations

Example 1: Purchase Transaction

Roland obtains a loan for $75,000. The appraised value is $100,000 and the purchase price is $101,000.

In this case,

Unpaid Principal Balance (UPB)  =  $75,000
Property Value (PV)  =  $100,000.
Lower of appraised value($100,000) and the purchase price($101,000)

Home Equity = PV - UPB = 100,000 - 75,000 = $25,000

Home Equity Rate =
(PV - UPB) PV
=
25,000 100,000
= 25%

Also,

LTV =
UPB PV
=
75,000 100,000
= 75%

Down Payment = Purchase Price - Principal = 101,000 - 75,000 = $26,000

Purchase Premium = Purchase Price - Appraised Value = 101,000 - 100,000 = $1,000
Source :www.MortgagesAnalyzed.com

Example 2: Refinance Transaction

Roland refinances his loan with an outstanding balance of $75,000. The appraised value is $90,000.

In this case,

Unpaid Principal Balance (UPB)  =  $75,000
Property Value (PV)  =  $90,000

Home Equity = PV - UPB = 90,000 - 75,000 = $15,000

Home Equity Rate =
(PV - UPB) PV
=
(90,000 - 75,000) 90,000
= 16.67%

Also,

LTV =
UPB PV
=
75,000 90,000
= 83.33%

CLTV =
UPB PV
=
75,000 90,000
= 83.33%
Source :www.MortgagesAnalyzed.com

Example 3: Two Loans

Roland obtains a first lien loan for $75,000 and a second lien loan for $5,000. The appraised value is $100,000 and the purchase price is $101,000.

In this case,

Unpaid Principal Balance for First Lien (UPB1)  =  $75,000
Unpaid Principal Balance for First Lien (UPB2)  =  $5,000
Property Value (PV)  =  $100,000.
Lower of appraised value($100,000) and the purchase price($101,000)

Home Equity = PV - (UPB1 + UPB2) = 100,000 - (75,000+5,000) = $20,000

Home Equity =
[PV - (UPB1 + UPB2)] PV
=
20,000 100,000
= $20%

Also,

LTV1 =
UPB1 PV
=
75,000 100,000
= 75%
LTV2 =
UPB2 PV
=
5,000 100,000
= 5%
CLTV =
(UPB1 + UPB2) PV
=
(75,000 + 5,000) 100,000
= 80%
Down Payment = 101,000 - 75,000 - 5,000 = $21,000

Purchase Premium = 101,000 - 100,000 = $1,000

Source :www.MortgagesAnalyzed.com

Example 4: Appreciation and Loan Repayments

Roland purchases a home on Jan 1, 2005 at an appraised value of $100,000 and a purchase price of $101,000. He obtains a 30 year fixed loan for $75,000 at 6% interest. As of Jan 1, 2014 the property has appreciated and is valued at $180,000. Assume that he made the monthly payment that was due on Jan 1, 2014. What is his home equity as of Jan 1, 2014?

At the time of purchase

Unpaid Principal Balance  =  $75,000
Property Value (PV)  =  $100,000.
Lower of appraised value ($100,000) and the purchase price ($101,000)

Home Equity = PV - UPB = 100,000 - 75,000 = $25,000

As of Jan 1, 2014

Principal Loan Amount (P)  =  $75,000
Unpaid Principal Balance (UPB)  =  $64,214.68
Principal Payments  =  P – UPB = 75,000 – 64,214.68 = $10,785.32
Current Property Value  =  $180,000
Appreciation  =  180,000 - 100,000 = $80,000

Home Equity = Current Property Value – UPB = 180,000 - 64,214.68 = $115,785.32

Home equity can also be calculated by adding equity at the time of purchase, property appreciation, and principal payments.

Home Equity = 25,000 + 80,000 + 10,785.32 = $115,785.32
Source :www.MortgagesAnalyzed.com

Updated: Nov 24, 2013

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Home Equity is the amount of homeowner's investment in a real estate.
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