What does “Equity” mean?

In the context of borrowing, property equity is a term that is used to describe the value of ownership that has been built up in a property or other asset. It represents the difference between the market value of the property and the amount still owed on the mortgage. As you make repayments on your mortgage, and as the value of your property increases, your equity in the property also increases. This concept is fundamental to understanding how mortgages work and how homeowners can leverage their property to secure additional financing.

Equity is not a static value, but rather, it fluctuates over time due to a variety of factors. These can include changes in the property’s market value, additional payments made towards the mortgage, or the accrual of interest on the mortgage. Understanding how these factors affect equity can help homeowners make informed decisions about their property and their financial future.

Calculating Equity

Equity is calculated by subtracting the outstanding balance of the mortgage from the current market value of the property. If the result is a positive number, this indicates that the homeowner has equity in the property. If the result is negative, this indicates that the homeowner is ‘underwater’ on their mortgage, meaning they owe more on the mortgage than the property is currently worth.

It’s important to note that the market value of a property is not a fixed number, but rather, it is determined by a variety of factors including the condition of the property, the location, and the current state of the real estate market. Therefore, the equity in a property can change over time as these factors change.

Example of Equity Calculation

For example, if a homeowner purchased a property for $200,000 with a $150,000 mortgage and the property is now worth $250,000, the homeowner’s equity in the property would be $100,000. This is calculated by subtracting the outstanding mortgage balance ($150,000) from the current market value of the property ($250,000).

This example illustrates how equity can increase as the value of the property increases. However, it’s also important to note that equity can decrease if the value of the property decreases, or if the homeowner takes out additional loans against the property.

Importance of Equity

Equity is important for a number of reasons. Firstly, it represents the portion of the property that the homeowner actually owns. The more equity a homeowner has, the more of the property they own outright. This can provide a sense of financial security and stability.

Secondly, equity can be used to secure additional financing. Many homeowners choose to use their equity as collateral for a home equity loan or a home equity line of credit (HELOC). These types of loans can be used for a variety of purposes, including home improvements, debt consolidation, or to finance large purchases.

Property equity and mortgage refinancing

Equity can also play a crucial role in mortgage refinancing. When a homeowner refinances their mortgage, they are essentially taking out a new loan to pay off their existing mortgage. The amount of equity a homeowner has in their property can affect their eligibility for refinancing, as well as the terms and conditions of the new loan.

For example, if a homeowner has a significant amount of equity in their property, they may be able to secure a lower interest rate when they refinance. On the other hand, if a homeowner has little to no equity in their property, they may have difficulty qualifying for refinancing, or they may be offered less favourable terms.

Building Equity

There are several ways to build equity in a property. The most straightforward way is by making regular repayments on the mortgage. Each time a repayment is made, a portion of the repayment goes towards reducing the outstanding balance of the mortgage, thereby increasing the homeowner’s equity in the property.

Another way to build equity is by increasing the value of the property. This can be achieved through home improvements or renovations, or through general increases in property values in the area. However, it’s important to note that not all improvements will necessarily increase the value of the property, and some may even decrease its value.

Accelerating Equity Growth

Homeowners can also accelerate their equity growth by making additional payments towards their mortgage. These additional payments can be applied directly to the principal balance of the mortgage, thereby reducing the amount of interest that accrues over the life of the loan and increasing equity more quickly.

However, before making additional payments, it’s important for homeowners to check the terms of their mortgage. Some mortgages may include prepayment penalties, which are fees that are charged if the mortgage is paid off before the end of its term.

Using property equity

As mentioned earlier, one of the main benefits of building equity in a property is that it can be used to secure additional financing. This can be done through a home equity loan or a home equity line of credit (HELOC).

A home equity loan is a type of loan that is secured by the equity in the homeowner’s property. The amount that can be borrowed is usually a percentage of the homeowner’s equity, and the loan is repaid over a fixed term, typically with a fixed interest rate.

Home Equity Line of Credit (HELOC)

A HELOC is similar to a home equity loan, but instead of receiving a lump sum, the homeowner is given a line of credit that they can draw from as needed. The amount that can be borrowed is usually a percentage of the homeowner’s equity, and the interest rate is typically variable.

Both home equity loans and HELOCs can be used for a variety of purposes, including home improvements, debt consolidation, or to finance large purchases. However, because these loans are secured by the homeowner’s property, it’s important for homeowners to carefully consider their ability to repay the loan before borrowing against their equity.

Equity and Selling a Property

When a property is sold, the equity in the property is the amount that the homeowner will receive after the outstanding balance of the mortgage and any other liens on the property have been paid off. This amount can be used to purchase a new property, or it can be invested or used for other purposes.

However, if the property is sold for less than the amount owed on the mortgage, the homeowner may be responsible for paying the difference. This is known as a short sale, and it can have significant financial and credit implications for the homeowner.

Example of Equity in a Property Sale

For example, if a homeowner sells a property for $300,000 and the outstanding balance of the mortgage is $200,000, the homeowner’s equity in the property is $100,000. This is the amount that the homeowner will receive after the mortgage has been paid off.

However, if the property is sold for $200,000 and the outstanding balance of the mortgage is $250,000, the homeowner has negative equity and will be responsible for paying the $50,000 difference. This is a situation that homeowners aim to avoid, as it can lead to financial hardship and damage to their credit score.

Equity explained

Equity is a crucial concept in understanding how mortgages work and how homeowners can leverage their property to secure additional financing. It represents the value of ownership that has been built up in a property, and it can fluctuate over time due to a variety of factors.

Understanding how to calculate equity, how to build equity, and how to use equity can help homeowners make informed decisions about their property and their financial future. However, it’s also important for homeowners to be aware of the risks associated with borrowing against their equity, and to carefully consider their ability to repay any loans secured by their property.

Now that you understand the power of equity in your property finance journey, it’s time to take the next step. At Funding, we’re committed to reshaping property finance to help you get ahead sooner. Our tech-forward approach simplifies the process, giving you the confidence to make the most of your equity. Ready to unlock your financial potential? Get Started today and experience the future of property finance and investment.