Equity, where finances are concerned, most often deals with homeownership. Essentially, equity represents your ownership in a home that you purchase with a mortgage.
How Equity Works
Since most people can't afford to buy a home outright with cash they need to turn to a lender for a loan. Once the borrower is accepted, the lender provides the loan for the house, called a mortgage. The homebuyer then repays the lender over time.
As long as the homebuyer owes the lender money on the mortgage, the lender can repossess the home. Over time, as the buyer makes payments on the mortgage, he or she starts to build equity or ownership in the home.
Another way to express equity is as the difference between what your home is worth, and what you still owe on the mortgage. As your home increases in value, you see more equity. If
your home is worth $200,000, and you still owe $130,000 on your mortgage, the
equity in your home is $200,000 - $130,000, or $70,000.
Equity is expressed as a percentage in many cases. In the example above, you have $70,000 equity in
your home, which is 35% of $200,000. Over time, you can eventually build up
enough equity to completely own your home, meaning you have 100% equity, and
the bank no longer has claim to ownership in your house.
The flip side is that you can also have negative equity in your home. This is when you owe more than
your home is worth. This can happen if home values drop. If you owe $180,000 on
your home, but it has dropped in value to $160,000, you have $20,000 in negative
Using the Equity in
As you build up
ownership in your home, you can use your equity as collateral for financing. If
you have $70,000 equity in your home, you might be able to borrow $40,000
against that ownership. You can make home improvements, pay off debt, or do
something else with the money. If you miss payments, though, the lender can
repossess your house, because now the home equity lender has ownership in your
home, and your own equity has been reduced to $30,000, or 15% (using the
$200,000 example above).
Equity is most
important when you sell your home. After you sell your home and pay off your
mortgage, whatever money you have left will be equal to the equity you had in
the house. If you've managed to build up a large amount of equity during the
time you owned the home, then you'll have a large amount of money ready to use
as your next down payment or to simply keep for yourself.