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Excuse me sir The 325K $ or what ever the amount the bank will lend me. 1- Will it be another liability? 2-If the market value of the house goes down. it will be a high risk to loss the house and equity ?
Its great to learn about this information, but why isn't he using a real balance sheet. That's what the problem, because we are adults and not kids.
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
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
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
Minus $1.075 -- that was the max that I could borrow --
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
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
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
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.
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