When someone lends you money, they do so based upon your ability to pay it back. Sometimes they use an asset to secure the debt in the event that you don’t pay. Rather than just lending you money that cannot be recovered, they lend you money to purchase the asset. If you are unable to pay the loan back, they can sell the asset to recover their initial funds.
The less you put down when you buy a home, the more risk the lender is taking, and thus, the more it costs them to manage the process if you are unable to make your payments.
So, they take out an insurance policy to secure the value of the loan when your downpayment is less than 20% of the appraised value of a home. They pass the premium on to you. So, you are paying a mortgage insurance premium to ensure that the lender can recover the full amount they loaned you.
To avoid this premium, simply pay down your mortgage so you have at least 20% equity in the home.
Equity is the value of a property after the deduction of the charges against it. Charges against the home could include a mortgage, commissions to sell, carrying costs (like HOA dues, lawn maintenance, pool maintenance, etc.), or any other liens on the property, etc.
For example, if you purchase a home for $300,000 and you put 20% down ($60,000) you will have equity in the home less than or equal to $60,000. The reason we say “less than” is because if you were to turn around and sell the property, you would:
- Pay off the initial loan of $240,000 + fees
- Pay any service professionals who help you prepare the home for sale and sell the home.
- Pay any other miscellaneous costs associated with moving.
So you wouldn’t necessarily have $60,000 in equity until the value of your home minus the charges against it were equal to $60,000. This is one of the considerations when thinking about short term and long term costs of ownership.
In simple terms, take what the home is worth, subtract all of the associated costs to sell it, and what you are left with is Equity.
A home equity line of credit is a revolving line of credit secured by a portion of the equity in your home. If you had a $300,000 home with $100,000 in equity, you might be able to secure a line of credit, a line of revolving credit, much like a credit card but with much lower interest rates, against that $100,000.
You probably won’t be able to access ALL of the $100,000 because the lender will most likely loan only up to 80% of the value of the home. If you already have a loan of $200,000 on the books, and 80% of the value of the home is $240,000, roughly $60,000 of your equity won’t be accessible. So you’ll be able to open a line of credit for approximately $40,000.
Lines of credit are typically secured personally as well as by a 2nd lien on your property. However, since the 2nd lien on a property is usually much less than the 1st mortgage lien, if you were to stop paying your monthly payments, the 1st mortgage lender is going to be first in line to sell the asset (your house) to recover their money. If that happens, whatever is left over is paid to the next lien-holder. That would go to the line of credit. If there wasn’t enough to pay off the line of credit, you, most likely would be left with the responsibility of paying back whatever is still owed.
Lines of credit add risk to your life. Be very careful about how you approach them and what you would use them for. Remember, buying a home is buying an asset that will appreciate in value over time. As long as you leave your equity alone, it will grow with the value of the home. If you spend that equity through a HELOC on things that go down in value, you will not come out ahead.
Aside from a few things that I’ll mention, there’s one rule you can follow. If it’s permanently attached to the home, it stays with the home.
Permanently attached could be subjective, so we’ll say that if you need a tool to remove it because it’s bolted or screwed to the property, it stays with the property…unless…
…unless you’ve written it into the contract that a specific item will or will not convey with the sale and both parties agree.
In the Residential Resale Real Estate Purchase Contract, there’s a section called Fixtures and Personal Property found in section 1g currently on page 2 of 10. (10/26/2017) It is included below.