While reading through big short , I came across this sentence, ‘People with first mortgages had vast amounts of equity locked up in their houses’. What does this mean.
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It means your house has value. If you take a mortgage to buy the house, most of that value is locked up in the loan. Basically, you have a house with say $300k in value. But you owe almost $300k to the bank. So the two cancel out. Building equity is what happens as you pay that loan down.
For an easy example, say that home will always have a value of $300k. As you pay down the loan you build up equity. So lets say you reach a point that you’ve paid off $100k of the loan. You know have $100k in equity in the house.
What they are saying is that you now have $100k of value just sitting in the house doing nothing. Unlocking the equity would mean refinancing or taking out a second mortgage on the house. This would allow you to “pull” the $100k of equity out of the home and into cash. The downside is you now have to pay off that same amount of money again. The upside is you have the money to invest into something that will hopefully return more than the interest on the new loan.
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