Definitions

Your Home Equity is the difference between the market value of your house and all the mortgages you have on it.

In proper English it means: The more you reimburse the loan on your house, the more your house belongs to you.

And the more your house belongs to you, the more you can borrow in exchange of this “increase” of your personal assets.

This type of loan is called a Home Equity Loan if it’s a one shot loan. If you get a revolving one, it is a Home Equity Line of Credit (HELOC).

It seems pretty simple and not dangerous. Well… not really.

Risk Analysis

In Finance, there are many ways to analyze potential risks.

The most basic analysis is called What-if analysis.

It does not require any mathematical or statistical knowledge. It is 100% pure common sense.

You just have to ask yourself, what happens to this HEL (or HELOC) if this event happens.

In our case, What if the price of my house goes down?

Let’s take an example.

Say I’m buying a $1 million house.

And say, the market goes up and my house is worth $1.5 million.

I’ve got a first mortgage of $1 million, but my banker calls and says I can borrow another $0.5 million.

Why wouldn’t I? It’s my house. It’s my money. I deserve it.

So now I’m with $1.5 million borrowed

But WHAT IF the market goes down and the price of my house is now back down to $1 million?

The hope to be able to reimburse these $1.5 million is gone as there is no way in the world I’m gonna be able to sell my house.

This is why I would call these loans, VIRTUAL MONEY.

Besides the house does not belong to you as long as the last down payment is PAID!

So now you are with $1.5 million of mortgage, the house is not yet yours, you gonna probably default.

Besides, you neighbor did the same, so the real market price of your house goes down even more, so if you did not default yesterday, you gonna probably default today or tomorrow.

Virtual Money

In Finance, as in life, there is no free lunch.

There is no return on investment without a risk.

Big or small is not the important thing about risk. The most important for you is to KNOW and UNDERSTAND the risks.

As long as you know the risks, you’ll make smart investments.

But beware of virtual money. There is no such thing as an easy way.

Wealth = [What you earn] – [What you spend]

You can only create value by working and/or spending less.

If you liked this post, you might want to read

https://www.finextra.com/blogs/fullblog.aspx?blogid=3737

https://www.finextra.com/blogs/fullblog.aspx?blogid=3539

https://www.finextra.com/blogs/fullblog.aspx?blogid=3517

Feel free to comment.
Cédric Pariente

Original Post
http://b32trust.blogspot.com/2010/02/home-equity-loan-home-equity-line-of.html

Original Post French Version
http://cartesdepaiement.blogspot.com/2010/02/home-equity-loan-home-equity-line-of.html