Housing equity loans | Housing | Finance & Capital Markets | Khan Academy


Welcome back. In the previous video we had
this very positive scenario, where I had originally bought
a house for $1.5 million. Then a year later, the value of
the house, or at least my perceived value of the house,
went up to $1.5 million, because my neighbors sold
their identical house for $1.5 million. And so my initial equity
investment went from $250,000 to $750,000. And why is that? Well equity is nothing but, if
I have an asset that’s worth $1.5 million, and I owe
$750,000– that was my original mortgage on that
asset– then what I’m left with is the equity. So my equity just tripled. It went from $250,000
to $750,000. In this video, what I’m going
to do is I’m going to show you, well, what can you
do with that equity? I mean, it’s not cash. It’s kind of like this make
believe amount of wealth that you have. You just
feel richer. And I’ll show you that you can
actually turn it into cash using something called
a home equity loan. And I’d argue that this is
actually what drove our economy from about 2002 to
probably still, to this day. Although I think we’re
in a recession now. In fact I’m about 100%
sure we are. But definitely until
about 2006. So what’s a home equity loan? Well I go to the bank. I say, wow, bank, I have this
$750,000 of equity. I wish — I’m rich, but I
don’t have this in cash. I want to do something, though,
with the equity. I would like to live
like a rich person. Well the bank says, Sal,
you know, you’re right. Our only requirement is that
you have $250,000– or our only requirement is that
you have 25% equity in your house, right? Because they want a cushion in
case you can’t pay and they get the house back, and they
have to foreclose, and auction off the house, et cetera,
et cetera. So they said, well, we’re
willing to lend you up to 75% of the value of your house. So what’s 75% of the
value of my house? So let’s see, 1.5 times 75%,
let’s see that would be $750,000 plus half
of $750,000. It’ll be 1.075 million,
I think. I did that in my head,
it could be wrong. But it’s roughly the
right number. So the bank says, you know what,
we’re willing to lend you up to 75% of the value
of your asset. And it’s of course going to be
guaranteed by this asset. So far, we lent you $750,000. So let’s see how much you
have more that you can borrow from us. Minus — we’re talking millions
— that’s 0.075. So that’s what? 300, that’s 250 plus 75, so up
to $325,000 more that you could borrow. And what is this? Where am I taking this
money out of? Well I’m essentially taking this
money out of the equity of my house. And how does that make sense? Well, what’s going to happen? Let’s say I take this loan. Let’s say I say, bank, great. I want $325,000 in cash. I want it right now. So what happens? Let me draw another series,
another balance sheet. I stopped using the word balance
sheet, even though that was the original purpose
of this whole discussion. I’ll draw it a little
bit bigger. Remember liabilities plus
equities are equal to assets. So what are my assets now? So now I have a $1.5 million
house, and I also got $325,000 cash from the bank, so we
can call that 325K cash. Got it from the bank. Now what are my liabilities? Well I have the original
mortgage on my house. The original mortgage
is $750,000. This is liabilities
on this side. Well not the whole side,
we’re going to have equity down here. So just this is liability,
$750,000. And then I took a new loan to
get this $325,000 of cash. So I have a new loan here,
that amount is $325,000. And this was a home
equity loan. I took a loan against
the equity that I have in my house. This was the equity
in my house. So what’s the leftover equity? Let me just make everything
clear. These are liabilities. These are assets. And equity is what you
have leftover. So what are my assets? I have $1.825 million in assets,
minus — now what are my liabilities? Minus $1.075 — that was the
max that I could borrow — liabilities. Assets minus liabilities
is owners equity. So let’s see, 825 minus 75. I still have $750,000
of equity. And that makes sense. If I just enter into some
transaction where I get cash in exchange for debt, my equity
shouldn’t change. But now what does happen? Well I have this cash, and I’m
feeling rich, because I’ve never seen numbers
like $750,000. And that neighbor, that new
neighbor that just bought that house right next door for $1.5
million, he just bought a beautiful new Hummer. And being a very down-to-earth
person, I feel that I also deserve a Hummer, like my
neighbor, because I am just as rich as they are. So I go decide to go out
and I’m going to spend $100,000 on a Hummer. Actually, let’s not do a Hummer,
because a Hummer could actually be considered
an asset. I want pure consumption. Although I think a Hummer is as
pretty close as a car gets to pure consumption. Let’s say that neighbor went on
a round-the-world vacation for $100,000. And I too, because I did nothing
but sit on my house and made $500,000 last year, I
feel that I also deserve a $100,000 vacation. So what I do is I take $100,000
of this cash. So I’m now left with just
$225,000, and I have the great experience of going
on a vacation. But of course I didn’t get any
asset in return for that. Although maybe your happiness
is an asset, I don’t know. But it doesn’t show up on
your balance sheet. So we had $325,000 in cash. Now we have $225,000 in cash. So our total assets went
down about $100,000. What are our assets now? It’s $1.725 right? Because we spent $100,000
of our cash. So what’s going to be the
liabilities and equity? Well the liabilities won’t
change, right? Just because I went on vacation,
the bank’s not going to say, hey Sal, you
owe us less money. I still owe the almost
$1.075 million. The $100,000 is going to come
all out of my equity. So now all of a sudden I
don’t have $750,000. I only have $650,000. And this isn’t the balance
sheet just for my house. This is kind of my whole
personal balance sheet. And now my whole personal
balance sheet, what just happened? I just took some of that
original equity that I had. I took $100,000 of it, turned it
into cash, and just went on a great one-year-long
vacation. And this is what home
equity loans are. And this is what, I would argue,
drove the economy. Or at least took us into
an expansionary stage from 2002 to 2003. Because if you remember, a lot
of people were still getting laid off in 2002, 2003,
but consumer spending kept going up. So people are earning
less money, or they don’t even have a job. How is spending going up? Well, the values of their
house went up, and they borrowed against the value
of their house. They took cash out of it, and
they used that cash to buy their Hummers, to go on
vacation, to buy fancy clothes, whatever. And that drove the economy. And in the next video I’ll
actually talk about, maybe, why those housing
prices go up. Or why they went up, in
particular, during this housing boom, this one that
we’re definitely in the process of getting out of. See you in the next video.

Paul Whisler

43 Comments

  1. You're right. Although I wanted to show how home equity withdrawal made people feel rich and consume more. Education, for the most part, is an investment and, assuming the student is responsible, will generate a return.

  2. Its never too early to learn about managing your money.

    I just don't really understand why you owe the bank 325k when its coming out of your house.

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  4. Question:
    bank says you can borrow up to 75% of home's worth=$1.25m

    but in this case, you can only borrow $375k because of mortgage?

    If you did not have mortgage, would you have $1.125m is cash and liability?

  5. Hello, what happens if an identical house is sold for 500k. Could the bank ask for money back (75% of 500k) immediately?

  6. 6:40, I disagree that happiness doesn't show up on balance sheet. If you think about it, every asset you have is contingent on your health and happiness. It's the reserve asset in most people's balance sheets.

  7. came on…

    you have $750k equity and asset and you spend 100k on vacation and you are left with $650k. is this a lesson?

  8. at the end after he said people were taking out equity loans all the while not having a job, but spending money like crazy, he should said 'and that drove the economy DOWN'

  9. It's hard for people to not spend money when they have a lot of it. So loans like these made people feel rich, when in fact, they were on a high produced by rising real estate. When real estate plummeted, the home owner was left holding a huge loan (in addition to their initial mortgage) after living like a king for a couple years. Did it happen to everyone? No, but even 50% is a disgusting huge amount. Foreclosures reached an all time high.

  10. thanks for the video

  11. your home is not an asset if it is taking money out of your pocket…. its an asset to the bank but not you…..so the whole 1.5m should not be in the asset column but the appreciation so equity gained works in your favour to be an asset

  12. Heey 25% off 1.5 million isn't 325k but 375k. An easier way to calculate the 25% is to halve it twice instead of taking 75% off.

    Example : 1.5M /2 > 750k /2 > 375k

    Having basic ways how to calculate really helps, if you mess one number up the whole balance is wrong.

  13. the bubble has burst now! explain that to the people on the bottom of the collapse. not everyone wants to live beside you when it hits the fan. the neighbor will not be able to pay his mortgage. three houses have been empty for 5 years. my neighbors and i have supported the thieves and vandals. greed fueled this mess! you toad!

  14. Something doesn't add up here: the house liabilities equal the house asset in the first box. What about interest? That would make taking out a loan for consumption even worse than you see here.

  15. he didnt explain how the equity of $250k tripled to $750k at the beginning and im really curious how it works

  16. and i thought the equity was a property left over by the $1.5m minus liability of $750 …

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  18. Hihi, have you considered this program called the Intellitus Cash System? (do a google search). My cousin says it gets people oodles of cold hard cash.

  19. Am I the only one that'd be afraid to borrow against something who's value is in flux? It seems that you've only really made money once you sell your house for 1.5m and borrowing off equity is just putting you further into debt.

  20. Home equity loans are a TRAP, designed to steal your property.  Read the TRUTH in the short, cheap Kindle Ebook "Don't Do It!"  The home you save may be your own.

  21. In this scenario could he have refinanced his home at the new market price and use the 500k equity increase towards his original $750k loan? Making it so he only owed 250k?

  22. What do you think about HELOCs being used for an accelerated mortgage payment. Taking advantage of daily interest vs monthly interest calculations on the balance. 
    It would be interesting what the calculations would look like 

  23. I dont get it. If your mortgage increases from 250K to 750K due to the appreciation of house value by 3X the amount, then surely it just increases the value of your mortgage, so now you have to pay treble the amount of money back to the bank, which increases your debt which is a bad thing right??

  24. assets are things that you own free and clear! You DON"T own the house, the bank still owns it…

  25. This example would be a bit less confusing if the Liability and Equity were two different numbers. Also, 75% of 1.5 million is 1.125, not 1.075 lol

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