Equity

In the world of hard money loans, your home equity plays a significant role in your loan amount, terms, and more. But what exactly is equity? Read on to learn everything you need to know about this term.

In the most basic sense, your equity is the portion of an asset that you personally own. As it relates to home ownership, your equity is the portion of your home’s value that you own, as opposed to the portion that a lender owns. 

Let’s break that down further. For most day-to-day purchases like groceries or clothing, equity isn’t a concern. Those items are paid in full upon purchase. When buying a home, however, most people seek the help of a mortgage to finance the purchase. 

At purchase, you pay a down payment and your lender pays for the rest. At this point, your home equity is the value of your down payment. With each mortgage payment, your home equity increases. When your mortgage is paid off, you own 100% of the equity in your home.

Unlike traditional loans, which are secured by your creditworthiness, hard money loans are secured by a “hard” asset like your home. Lenders agree to lend you a percentage of your home’s total value, known as the loan-to-value (LTV) ratio. 

In order to determine your loan’s LTV,, lenders estimate the risk associated with your loan. Equity is one of the main factors in determining your risk.Generally speaking, the more your home equity, the lower your risk and the higher LTV a lender is willing to offer. 

Taking out a hard money loan also affects your equity. Once you take out the loan, your hard money lender owns a portion of your home and your home equity decreases. 

Equity can be calculated and expressed in two different ways: as a monetary value or as a percentage. 

(core mechanics or process / step‑by‑step breakdown or schedule)

When determining your loan’s LTV, your lender may calculate the monetary value of your home equity. They’ll use this formula: 

Equity ($) = Home’s total value – Outstanding loan balance 

Let’s say you have a home that’s $400,000 and an outstanding loan balance of $200,000. 

Equity ($) = $400,000 – $200,000 

In this example your home equity is $200,000.

In some cases, a hard money lender may refer to your home equity as a percentage. They’ll use this formula to calculate it: 

Equity (%) = (Monetary home equity  / Outstanding loan balance) x 100 

In the above scenario, equity is calculated as follows:

Equity (%) = ($200,000 / $400,000) x 100 

In this example, you have 50% home equity. 

Use these real-world scenarios to gain a deeper understanding of equity and how it relates to hard money loans. 

You’re purchasing a home for $500,000. At the outset, you make a 20% down payment of $100,000 and take out a loan for the remaining $400,000. Your equity is: 

Equity ($) = $500,000 – $400,000 

Your monetary equity is $100,000. 

Equity (%) = ($100,000 / $500,000) x 100 

Upon purchase, your home equity is 20% and your lender’s equity is 80%. 

As you pay off your mortgage, your equity grows and your lender’s equity shrinks. After your final loan payment, you have 100% home equity and your lender has none. 

10 years into owning your home, your outstanding mortgage balance on your $500,000 home is $300,000. That means you own $200,000, or 40%, home equity. 

You apply for a hard money loan using your home as collateral.. Based on a number of factors, including your 40% equity, your lender determines that you can borrow up to 50% LTV, or $250,000. You decide to take out a loan of $100,000. 

Now, your mortgage lender owns $300,000 of your home’s value and your hard money lender owns $100,000, for a combined $400,000. Your new equity is calculated as: 

Equity ($) = $500,000 – $400,000 

Your monetary home equity is $100,000. 

Equity (%) = ($100,000 / $500,000) x 100 

You again have 20% home equity and your lenders own a combined 80%.