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Current time:0:00Total duration:8:36

Video transcript

welcome back in the previous video we had this very positive scenario where I had originally bought a house for a million and a half dollars but then a year later the value of the house or at least my perceived value of the house went up to a 1.5 million because my neighbor sold their identical house for 1.5 million dollars and so my initial equity investment went from two hundred fifty thousand to seven hundred fifty and why is that well equity is nothing but if I have an asset that's worth a million in half and I owe 750 that was seven hundred fifty thousand dollars 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 two hundred fifty thousand to seven hundred fifty thousand in this video what I'm going to do is I'm going to show you well what does what 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 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 a hundred percent sure we are but definitely until about 2006 so what's a home equity loan well I I go to the bank and I say wow Bank I have all this this I have the seven hundred fifty thousand of equity I wish you know I'm rich but I don't have this it in cash I want to you know do something that with equity I would like to live like a rich person and well the bank says Sal you know you're right you know our only requirement is that you have two hundred fifty thousand dollars or the our only requirement is that you have 25 percent equity in your house right because they want to push it in case you can't pay and they get the house back and they have to foreclose an auction off the house etc etc so they said well so we're low willing to loan up to seventy five percent of the value of your house so what's seventy five percent of the value of my house so let's see 1.5 times seventy five percent let's see we seven hundred fifty thousand plus half of seven hundred fifty thousand it'll be 1.0 750 I think 1.0 seven five million I did that in my head it could be wrong but it it's roughly the right number so the bank says you know what I'm willing to we're willing to lend you up to 75% of the value of your asset and the school of course going to be guaranteed by this asset so far we lent you 750,000 so you have let's see how much you have more that you can borrow from us - that's we're talking million 6.70 7-5 so that's what three hundred is two hundred and fifty plus seventy five so up to three hundred and twenty five thousand more that you could borrow and what is this what am I where am I taking this money out of well I'm essentially taking this money out of the equity of my house and and how does that make sense well what's going to happen well I still have a 1.5 let's say I take this loan let's as a bank great I want three hundred and twenty five thousand dollars of cash I want it right now so what happens let me draw another series of as another balance sheet I've stopped using the word balance sheet even though that was the original purpose of this whole discussion draw it a little bit bigger remember liabilities plus equity Zoar equal to assets I always whenever I draw anyway so what are my assets now so now I have a I have a 1.5 million dollar house and I also got $325,000 cash from the bank so we could call that yellow state 3 325 325 okay cash got it from the bank now what are my liabilities well I have the original mortgage on my house the original mortgage the original mortgage is $750,000 this is liabilities on this side well not the whole side we're gonna have equity down here so just this is liability 750 thousand and then I took a new loan to get this three hundred and twenty five thousand dollars of cash so I have a new loan here about this in that amount 325 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 so let me just make everything clear these are liabilities these are assets and equity is what you have left over so what are my assets I have one point one point one eight to five million in assets - now what are my liabilities - one point zero seven five right that was a max that I could borrow liabilities right assets my life ad sets - liabilities is owner's equity so let's see 825 - 75 I still have 750 thousand of equity and that makes sense if I just enter into some transaction where I get cash and exchange for debt my equity shouldn't change but now what does happen well I have this cash and I'm I'm feeling rich because I've never seen numbers like $750,000 and that neighbor that new neighbor that just bought that house across a right next door for 1.5 million dollars he just bought a beautiful new Hummer and 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 decide to go out and I'm going to spend $100,000 on the Hummer actually let's not do a Hummer because a Hummer could actually be considered an asset I want to I want pure consumption although I think a Hummer is 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 - because I did nothing but sit on my house and made five hundred thousand dollars last year I feel that I also deserve $100,000 vacation so what I do is I take one hundred thousand dollars of this cash so I'm now left with just two twenty-five and I have the great experience of going on a vacation but of course I didn't get any acid in return for that although you could maybe your happiness maybe as an asset I don't know but it doesn't show up on your balance sheet so we took we had 325 in cash now we have 225 in cash so our total liabilities go down by a hundred thousand so if our total at mr. sorry our total assets went down by a hundred thousand what are our assets now it's one point seven to five right because we spent a hundred thousand dollars of our cash so what's going to be the liabilities and equity well the liabilities won't change right just because I want to vacation the bank is not going to say hey Sal you always less money you should I still owe though almost you know what 1.07 five million dollars that hundred thousand dollars is going to come all out of my equity so now all of a sudden I don't have $750,000 I only have I only have six hundred fifty thousand dollars and you could do it and this isn't the balance sheet just from 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 a hundred thousand dollars of it turn 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 if people are earning less money or they don't even have a job how is spending going up well the values of the house went up and they borrowed against the value of their house they took cash out of it and they use that cash to buy their Hummers to to go on vacation to buy you know fancy clothes or 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 in the next video