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Home Equity: Home Equity Line of Credit

“Home equity” is a common term heard among those working to purchase a home or looking into mortgage refinancing.  Having a basic understanding of what home equity is and what it means to you is important, before you make decisions about a getting a loan for a mortgage refinance or a home purchase.  

The difference between the appraised or market value of the home and the amount of your home loan is your home equity.  When you put money down on a home, or make your down payment at closing, you are actually paying for equity in your home.  The lender will usually only lend you 90% or less of the appraised value of the home.  This will give you a 10% or more home equity to start with.   

When you purchase a home the amount of the loan you are able to qualify for is based on the appraised value of the home, rather than the asking price of the home from the seller.  The lender will send a licensed appraiser to go to the home and figure its market value by evaluating the home and looking at the recent selling prices of similar homes in the area.  This gives the lender confidence that the property is worth a certain amount, and he will base the amount of your loan on that value.  This lowers the risk of the lender because if the borrower defaults on the loan, the lender should be able to sell the home for the appraised value and recover most, if not all of his money.   

Understanding the home equity is an important factor when you are looking at a mortgage refinance, and especially if you have bad credit.  If you do a streamlined refinance, you are simply rolling the loan over to a new interest rate.  However, if you are getting a cash-out refinance, your home equity will be the determining factor in the amount of cash you can receive from the process.  For example, if your home's value is $100,000 and the current amount of your mortgage loan is $60,000, you have $40,000 in home equity.  The bank will lend you up to 80% of the value of the home, so your mortgage refinancing nets you a new loan of $80,000, and you may be able to get $20,000 out in cash to use elsewhere.   

If you have bad credit, you may need to get a bad credit mortgage when you refinance.  You may be able to use the cash out from your home equity to pay off a high interest debt so that you can make your mortgage payments more easily.  Making your payments on time or paying additional money to the principal of the loan will help your equity to grow more quickly.  This will put you in a better financial position in case you need to do any type of refinance or other mortgage transaction in the future.