WHAT IS EQUITY?

What is equity?

Equity means "amount of ownership". To completely understand how equity works, you must understand another strange word. That word is "amortization". Amortization simply means the regular reduction of principal (the amount you owe on the loan).

Out of your monthly mortgage payment, the lender will take part of it for interest, and part of it will go towards reducing the amount you owe. After all, the whole point of making mortgage payments is to pay down the loan until it is paid off, right? Once you pay off the loan, the house is yours, right? So, who owns the house before the loan is paid off?

That is where equity comes in.

During the days prior to closing, the lender will order an appraisal on the property you want to buy. That makes good business sense. The lender must make sure that the house is worth the amount of money that they are going to loan you. The math is pretty simple. If the appraiser says your house is worth $200,000 and you put $10,000 down on the loan, then you own $10,000 worth of the house and the bank owns $190,000 worth.

Your equity is $10,000.

As you make more and more payments, two things happen.

1. The amount you owe on the loan steadily decreases (amortizes).

2. Your equity steadily increases.

Historically, homes appreciate - increase in value - over time.

(OK, maybe not so much in today's economy, but we are speaking historically here.) By the time you have lived in your $200,000 home for a few years, hopefully, it will be worth more than it was when you bought it. There are a couple of ways to know for sure if your home is appreciating:

1. Have it appraised. An appraisal can be costly, though ($250 to $500).

2. Get a CMA (comparative market analysis). A CMA is a report done by a realtor in which she checks the prices of recently sold homes in your area that are comparable to yours. This will give hard facts about what buyers are willing to pay for homes like yours. Realtors will do a CMA for free. If a realtor tries to charge you for a CMA, move on. You're dealing with a dishonest agent.

Allowing for amortization of your loan and appreciation of the homes value, you should be building equity in your home pretty quickly. But you will not have 100% equity (ownership) in your home until you pay off the loan. Until then, you and the bank are co-owners.

I hope this answered your question: "What is Equity?"

Not seeing what you searched for? Try again