Home equity is an important term to understand when you’re applying for any kind of mortgage loan, but for some loans equity is a larger factor than others. For example, when you apply for a new purchase FHA loan to buy a home, you start out with 3.5% of the adjusted price of the home as your equity. That’s the amount of your down payment, and the equity grows over time with the number of payments you make.
When you apply for a home equity loan, a home equity line of credit, or an FHA Home Equity Conversion Mortgage (HECM), you’re applying for a loan based on the amount of equity you have built up. HECM loans in particular require the property to be either paid in full or very close to being paid off. You are taking out a loan against that full equity in the property, and in general for HECM loans the note is not due until the borrower dies or sells the home.
Equity in the home is not the same as the appraised value of the property. The equity is the current market value of the property minus any remaining payments you have to make, so equity depends on the market value of the home. That is why, in 2008 when property values dropped, many home owners reported being “underwater” on their homes, owning more than the property was worth on the market at the time.
As the housing market recovered and property values rose once again, the amount of equity a homeowner had also went up depending on how many payments were left on the mortgage. A property that grows in value also grows in equity.
Equity is not what people in the financial industry call “liquid”, so you can’t “spend” the equity in your property as such, but you can take out a loan to take advantage of that equity. Borrowers who have paid on their mortgages for a long time have more equity to take advantage of than those who have only been paying for a few years.