I'm almost sure this is a stupid question, but it seems like if I paid
that portion of my mortgage (my equity), that portion belongs to me in
some sense. Why do I have to "borrow" from it and pay interest on it,
if it's already my own money?
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It's not clear what you're actually asking, but perhaps you need some
clarification on what equity is and what a home equity loan is.
Equity is what's left after all the debts have been paid off. The
actual value of it varies all the time, of course. But it's NOT "the
portion of your mortgage you've paid off". If you took out a $100,000
mortgage to buy a house for $125,000, you have $25,000 equity the day
you bought the house. If the house goes down in market value by
$20,000, you have, theoretically, $5000 equity now -- it's not directly
related to how much or how little of your mortgage has been paid off but
rather the difference between your remaining debt and the actual value
of the property. If the house never changes in value but you pay down
your debt, then, yes, your equity increases exactly with those paydowns.
As far as the home equity loan, there's a difference between borrowing
your equity (which you really can't do -- see above) from yourself and
borrowing cash from a bank. When you get a home equity loan you are
borrowing money from the bank, not yourself. The loan is
*collateralized* by the house and equity - if you default on the loan,
the lender has a claim on the house.
But make no mistake - when you take out a home equity loan, you are not
borrowing from yourself. You are borrowing from the bank. And the bank
has every reason to charge you interest on that money. Why wouldn't it?
The flip side is that if the home appreciates in value, that increase in
value falls to the equity as well -- the bank doesn't get to keep that
appreciation - the owner of the equity -- you -- do. In the example
above, if the house goes from $125,000 to $150,000, the bank doesn't get
to keep any of that increase. You suddenly have $50,000 in equity --
which you may use as collateral or, if you sell the house and pay off
the loan, you may spend any way you like. And that same logic applies
to the home equity line, too -- if you borrow against the equity and the
house appreciates in value, your loan from the bank hasn't changed - you
still owe the bank the same amount of money. The bank may be happier,
though, in that if you do default on the loan, the more equity there is
in the house, the more likely the bank will get its loan paid back.
What do you mean "have to"? Who is forcing you to do so?
I think the real question you are asking is, "why won't someone give my my
equity in cash?" Well, who do you suppose would do that? And why would they?
To access the equity in any sort of property, you have to either sell it or
borrow against it. If you can sell part of your house to another party, then
you won't have to borrow anything. Or sell the entire thing and pay off the
remaining mortgage, leaving the equity in cash.
It's not your money. You exchanged it for the house.
Think of it this way: if you paid all cash for the place, why would
anyone lend you what you mistakenly characterize as "your own" money
(without charging you interest on the loan)? Again, just to make it
clear, you exchanged "your money" for someone else's house. Now *they*
own "your money" and you own "their house."
Not to 'soap box' this, but possibly one of the reasons for the bubble
in real estate is that people conceptualized a house as a source of
financing and of "equity." As Bread explained in detail, the "equity"
fluctuates, and is only realized when you exchange your house for the
buyer's money. Because so few people can pay for a house, a "mortgage"
is almost a given, but the word itself means a schedule of payments of
interest + principal which will "liquidate" ("kill") the loan.
It isn't a "stupid" question; it's a request to clarify a confusion
which to many is 'smoke and mirrors' of mortgages and equity and fees
and charges. Keep the basics straight. You didn't deposit your money
with the bank as a "down payment" - you actually bought the entire
house, from the dirt to the highest shingle. The seller took the check
for the price, paid off whatever remained of his loan, and kept the
balance. "Your" bank agreed to finance what you did not have the money
to pay for (lent you the balance of the settlement price).
Your equity in your home shows up on your balance sheet as the
difference between the market value of the house and the mortgage.
But you can't spend equity. You have to borrow cash using the equity
You aren't paying interest on it.
The way mortgages work, you pay interest on the unpaid balance of the
loan at the fixed interest rate (assuming it's a fixed-rate mortgage).
You might say, "But my monthly payment is constant." Sure, but the
split of that payment between interest and principal changes each
month. As you pay off the loan, the interest portion decreases.