The other day my wife, who works for a major Credit Union, told me that many of her customers do not know the meaning of equity when applying for a mortgage.
Sometimes mortgage professionals take for granted that homebuyers, especially first time buyers, understand the terminology of mortgage financing. This is a big mistake.
So, today I am going to talk about EQUITY as it applies to homebuying and mortgages.
Simply stated is the value less what is owed on it.
For example: A person owns a house that is worth $500,000.00
And they have a mortgage(s) balance of (-) $300,000.00
The equity in that property is $200,000.00 = Pure Equity
Banks & Mortgage companies use a diffferent formula if the same borrower wants to refinance the house
The formula works like this: Same House Value of $500,000.00 X 80.00% (can be more or less depending on the lenders criteria) = $400.000.00 Total Lendable Equity.
Now the lender will deduct the amount currently owed - $200,000.00 and that leaves the amount the owner can homeowner can get in cash ----------- $100,000.00 Net Lendable Equity
On home purchases, equity is described as the 'down payment' On many mortgage programs, a bigger down payment will result in more a favorable mortgage program: eg. Interest Rate, Term of Loan etc.
The least amount required for a down payment in todays market is through the F.H.A. Program.
F.H.A. guidelines allow as little as 3,50% down payment of the purchase price. Using the same example as above but on a PURCHASE: Purchase Price = $500,000.00 X 3.50% = $17,500 Down Payment
This low down payment requirement helps many 1st time buyers get thier 'dream house' but there are tradeoffs. The major one is that ALL Mortgages granted with less than 20.00% down payment require private mortgage insurance, aka PMI or on F.H.A. Insured Mortgages Mortgage Insurance Premium aka MIP
The initial cost of the PMI or MIP can be included into the mortgage, however the MONTHLY charge will be added into the mortgage payment.
In the example above, the MIP monthly payment could be as high as $241.25, this amount will be added the mortgage Principal & Interest and the escrows for Real Estate Taxes and Hazard Insurance. The total payment will be calculated into the borrower(s) gross monthly income for qualification.
Equity is a very important factor for lenders in determining a customers credit worthiness. This is why is strongly urge all potential homebuyers to speak with a mortgage professional before they begin looking at houses.
I hope this helps all you future (and current) homeowners.
Ken Nelson
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