You have probably heard the word equity at least once in your lifetime. Whether it be in conversation, advertised in a commercial on TV, magazines, etc. but what does it mean exactly? Well, we wanted to make it easy for you and explain it simply, so it's easy to understand!
Home equity is defined as "The current market value of a home minus the outstanding mortgage balance. Home equity is essentially the amount of ownership that has been built up by the holder of the mortgage through payments and appreciation." This is simple textbook definition, but I'd like to elaborate upon it. When you purchase a home, you pay an initial percentage upfront as your down payment and this is essentially where you establish or start building your equity. From here, as you pay against the principle, you acquire equity. For people who pay a larger percentage as their down payment, this can be advantageous because they then have a higher amount of equity that has potential to grow.
This is where the importance of property values come into the picture. As the years pass by, and property values are normally likely to increase (they can & have decreased), your overall equity in your home grows. Here is a great example of how home equity is calculated:
Pat and Morgan bought a house in September 2009 for $172,000. They made a 20% down payment and refinanced 3 years later.
Here's how equity is calculated:
Home's current appraised value: $190,000
Amount Pat and Morgan owe on mortgage: $128,633
Appraisal minus amount owed: $61,367
As you can see from the example above, just from the natural increase in property values over 5 years’ time caused the overall value to increase $22,000 from the initial purchase price. Because the property value increased so did the owner's percentage of overall equity acquired. A different scenario that affected a great majority of Americans back in 2006 with the housing market crash was that people lost equity. What would change in the example is that their appraised value after 5 years came in lower than their initial purchase, and therefore their equity was a negative amount.
While there is much more we could share and explain about equity, we hope this shed light about what equity is and how it relates to you. Also, click on the picture below to access more Home Equity Calculators.