What is Equity? | Real Estate Definition

By December 3, 2011 TERM
What is Equity? - Real Estate Definition

What Is Equity?

What does equity mean in real estate? Well, equity is calculated by taking the market value of a property and deducting the amount, if any, still owing on a mortgage. Since property values fluctuate constantly while payments are also being made technically, equity is never the same from one day to the next.

Real Estate Agent Explains Equity

Equity can be increased by making mortgage payments, improving the property and overall rises in real estate values. On the flipside a decrease in the market value and increase in the loan principal amount (re-mortgaging the property) or damage to the property can all drag equity down.

For example, let’s see how equity could change over three years on a fictional home:

Chart - Total Equity Over Time

Changes In Total Equity Over Three Years

Legend:

Purchase:
Year 0 (a): +$12500 – A down payment of $12,500 is made
Year 1 (a): +$8331 – Total mortgage payments for the year (principal only)
Year 1 (b): +$5000 – Market value of the home increases this year
Year 1 (c): -$500 – The home depreciates (some minor things wear out)
Year 2 (a): +$8670 – Total mortgage payments for the year (principal only)
Year 2 (b): -$2000 – The market causes the home value to decrease this year
Year 2 (c): -$500 – The home depreciates (some other things wear out
Year 3 (a): +$9024 – Total mortgage payments for the year (principal only)
Year 3 (b): +$5000 – Market value of the home increases again this year
Year 3 (c): -$500 – The home depreciates (some more things wear out)
Year 3 (d): +$3000 – The homeowners renovate their home

You can see how equity is affected by all manner of events: mortgage payments, market forces, depreciation and even renovations. Of course the only way to find out how much a home is worth is to sell, so the values represented here are hypothetical. You can’t sell your home every time you do some work or something breaks down, but it stands to reason that if your hot water tank failed and that tank costs $750, then your home is worth about $750 less than it was when that item was working. And if you get brand new windows, your home will be worth more than it was before. You can add the value of those windows to the cost of the home (give or take of course).

A simple calculation of equity is:

(value of home) – (amount owing on mortgage) = (equity)

So for example, a home is worth $463,500 and the owners who have been living there a couple of years just received a statement from their bank that they still owe $425,300.

$463,500 – $425,300 = $38,200

If the home owners sold now, their equity would be $38,200. That is amount of money they would get once the mortgage was paid back from the proceeds of the sale.

Why Does It Matter?

Equity is an extremely important part of real estate. Everyone wants equity because it means more of the property belongs to the owner and has value. Without equity, a home cannot easily be sold or borrowed against, because more is owed to the lender than is owned. This is the reason that down payments are often required when property is purchased – to protect the lender from a loss in case of foreclosure. Equity becomes a buffer in case a homeowner defaults on a mortgage and makes mortgages quite a safe investment for banks. If a property has 100% equity, it means that the full value of the home is available to the property owner. That is, the property is paid off.

by +Alan F Macdonald REALTOR® | Copyright © – gimme-shelter.com
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Alan F Macdonald

Author Alan F Macdonald

Alan F Macdonald is a real estate agent with Maxwell Challenge Realty in Edmonton, Alberta.

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