With the market conditions the way they have been the last few years it’s no wonder why there are so many questions about value and equity. If you are like most Americans, you have seen the values of homes rise. New buyers who are financing have to consider how these new values match up to the amount of loan they have and current owners may wonder how they factor into the equity. If any of these terms are slightly confusing you are in luck because this is going to explain it all.
Loan to Value is a term you likely see when working on buying a home. It may be abbreviated as LTV and the value is usually represented as a percentage.
Your loan to value is how much money you owe vs the value of the home. I know no one likes math problems but lets do a simple word problem. Bob the buyer is purchasing a $250,000 home and has a 10% down payment of $25,000.
In this example Bob will owe $225,000 on the home, which is 90% of its value. His loan to value is 90%, meaning he owes 90% of its value. As the home appreciates in value over the years, which is normal over time, and Bob makes his regular payments, his LTV goes down and the amount of the home that he ‘owns’ goes up.
This is called equity. Equity is the value of the home minus the amount you owe. In our above scenario, Bob had $25,000 in equity when he purchased it. Over time as the home rises in value, and you make more payments, the equity goes up.
Most mortgage companies require you to carry, Private Mortgage Insurance (PMI) to protect them from loan default until your LTV his 80%. When that happens you should look into options for dropping the PMI. That could save you money in your budget to apply directly to the principal increasing your Equity even faster.
Note that even though he no longer has the $25k down payment in cash, or the cash from his monthly payments, he still has the money…its just tied into his home. This is what makes home ownership, and real estate in general, such a great investment.
It’s also a hedge against inflation. When you stay a renter, your cost of housing goes up over time and you retain none of that money, your land lord does. When you are a home owner, you lock in the cost of your housing with a monthly mortgage bill that doesn’t rise over time and that money is a guaranteed savings plan that eventually leads you to owning the home outright.
Under certain circumstances, it’s possible to owe more on your home than its value. We will talk about that next week and ways you can avoid it. Until next time….
Berkshire Hathaway-RW Towne Realty
252 312 2263