Equity simply means how much you own of a piece of property, whether it is a home, car, or even jewelry. Determining your equity is easy: Using your home as an example, take the value of your house, then subtract the mortgage you have against it. The remaining value is how much of the property you actually own (i.e your equity). Obviously, if you own an item outright, as might be the case with a piece of jewelry, you have full equity in it.
Equity can either be positive or negative, depending on how your ownership stake compares to the value of the property in question. For example, it’s negative if you owe more on a property than it is worth; this is called being ‘upside-down’ or ‘underwater’ on the property. These terms became real estate buzzwords during the Great Recession, but negative equity is actually far more common when purchasing a car, since the value of a car decreases just by driving it off the lot.
The rate at which you build equity obviously depends on how quickly you pay down your loan. That’s why someone with a 15-year mortgage will typically build equity faster than someone with a 30-year mortgage (we’ll stick with the mortgage example for the rest of this answer). Therefore, while home buyers typically decide on a 30-year mortgage because it requires a lower monthly payment, choosing a shorter loan term has its advantages. Not only will you build equity faster (unless you make extra payments on a 30-year mortgage), but you’ll also end up paying less interest over the life of your loan.
There are a number of other ways you can increase your equity:
Making a larger down payment: This will also shorten the term of your loan and make you more appealing as a borrower, since banks generally like as large of a down payment as you can afford.
Increasing value of area properties: You don’t have much of a say here, but your equity in your home might rise if the value of your home increases, as can happen in growing areas. This might not be very common for homeowners in the current market, but there are areas where home values are still rising.
Making improvements to your home:Often refered to as "Sweat Equity," adding features or putting in additions on your home can increase its value and therefore your equity. You just have to consider how much such a renovation or repair would cost against how much you expect your property value to rise. It’s also important to understand that letting necessary repairs go unmade can lower the value of your home and your equity.
Finally, you should know that your home could lose value because of events over which you have no control. For example, many home owners in Arizona and Florida saw their home values plunge 40% to 50% during the Great Recession, without any changes to the actual homes. While all home buyers hope their values will increase, there really is no guarantee, as things like flooding, fire, or even appliances breaking and causing damage can happen unexpectedly. It’s important for a borrower to realize that even if you make all the right decisions, sometimes your home might lose some of its value.