You bought your home for $500,000 10 years ago in a hot market area. You had a loan on it at the time for $350,000 after putting $150,000 down. In the last decade, you paid down $100,000 of that loan so that your remaining principal is $250,000.
From the bank's "book value" perspective, the loan-to-value ratio is now 50 percent. But the MARKET value of the home today is a million bucks. So that loan-to-value ratio is actually falsely conservative or overly conservative. It's really 25 percent...meaning that the bank's portfolio is safer than it might seem. That's where appraised equity capital comes into play.
By having the home's value appraised for the actual equity in it, the bank gets a different perspective (a much more real market-based one) on its level of risk in its loan portfolio. And this element matters to home owners as well who have Private Mortgage Insurance or PMI...usually required when the loan-to-value ratio is less than 20 or 25 percent. Should the home's equity go up a lot, that LTV gets more friendly and at some point, the home owner can then stop paying the non-tax-deductible PMI fees and save a few more bucks.
The notion of appraised equity capital isn't limited to homes or home loans...it applies to normal corporate bean counting...but you'll hear it most at home mortgage cocktail parties. And then you have to ask yourself, "Why am I here?" But that's a different glossary term.
Related or Semi-related Video
Finance: What are Systematic and Unsyste...14 Views
finance a la shmoop what are systemic and unsystematic risk systemic risks are
just endemic to the market want to invest in the stock market and compound [Plate of vegetable appear]
return your way into great wealth great but then you'll suffer the normal risk
of the system that risk specifically is this yeah best of times worst of times
but up over time the market goes up you just have to embrace the notion that [Man hugging a tree]
there is systemic risk in that in the short run you can buy an S&P 500 index
fund here then lose like a third or whatever of your money in not too many
years but if you don't panic and sell just at the wrong time here right out
the storm and keep going well then you should be just fine by the time you
arrive here so that's risk that is always in the system equities rise and [Equity in the ocean]
fall like the tides or something like that but generally they rise and if you
want to swim in this bathtub well you get used to the turbulence and have an [Girl swimming against the tide]
airsick bag handy all right that systemic risk or systemic risk
what's unsystematic risk well it's bad investors or rather bad investing it's
panicking and selling your stock just when you should be doubling down its
buying lousy companies thinking that they're cheap today but not realizing [Woman runs away from smelly girl]
that they will always be cheap because they're lousy or in a lousy industry or
run by lousy management it's buying into lousy industries that also look cheap
but are dying hello paper and pulp is yeah anyone really think that's gonna be [Paper printing]
around in 20 years all right well it's believing the dreamy hopes and prayers
of future earnings and trusting that there really will be 5 million [Traffic on the highway]
driverless cars on the road in 3 years you know good luck with that we'd love
it to be true but ain't gonna be unsystematic risk is also investing in
bonds for the long-term taking very little risk when taking little risk is
the opposite of what you should be doing when you're a young investor so yeah
systematic and unsystematic risk both exist plentifully and both can bite you [Dog bites portfolio from woman]
right in the portfolio so you got to know what both are and embrace them
for what they're worth
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