We hear the word “equity” used quite often in our world today, but have you ever stopped to think about what it really means? If you were walking in the city and a man dressed in a suit and tie ran up to you, shoved a microphone in your face, and questioned, “For $50,000, can you tell us “What is Equity?” I’d say that 90% of the population would answer incorrectly.
What is Equity
In general terms, equity is ownership. When one refers to “percent equity”, they are referring to the percent of the asset that you own. Since this term is most often used with real estate, let’s use your home as an example.
Let’s say you own your home free and clear. You have paid off the mortgage and you own 100% of your home. You can say that you have 100% equity in your home – you have 100% ownership of your property.
What if you just bought your home? You were a good girl or boy and put 20% down on the house. The bank paid for the other 80% in order for you to move in. So, how much equity do you have in your home? If your answer is 20%, you are most likely incorrect (don’t worry, I didn’t teach this to you yet). Equity is not dependent on how much you paid for the house, it is dependent on how much the house is worth.
So, let’s say you purchased the house for $100,000 and paid $20,000 (20%) for the down-payment (which mean the you owe the bank $80,000). As it turns out, this house is actually valued at $120,000 (you made a good buy – congrats)! Your asset is valued at $120,000 and your debt is $80,000, which means that your equity in the house is $40,000!
Negative Equity in the Housing Crisis
Do you remember the housing crisis in 2007 (how could you forget – it’s practically still going on)? The issue with the mortgages back then was one of equity. During the news reports, we repeatedly heard the phrase, “upside-down mortgages”. This simply meant that homeowners had negative equity in their homes! They owed the bank more than what it was worth. If they would have sold the home, they would have had to pay the bank more money in order to clear their debts. This led to many mortgage defaults, and ultimately, the temporary downfall of our economy.
Do you have a positive equity in your propertires! Hopefully, you have 100% equity! 🙂
My name is Derek, and I have my Bachelors Degree in Finance from Grand Valley State University. After graduation, I was not able to find a job that fully utilized my degree, but I still had a passion for Finance! So, I decided to focus my passion in the stock market. I studied Cash Flows, Balance Sheets, and Income Statements, put some money into the market and saw a good return on my investment. As satisfying as this was, I still felt that something was missing. I have a passion for Finance, but I also have a passion for people. If you have a willingness to learn, I will continue to teach.