What is equity?
In real estate, equity is the percentage of a property that a person or entity owns free and clear. Without equity, a property cannot easily be sold or borrowed against, because more is owed on the property than is owned of it.
Generally defined as the difference between the market value of a property and the amount that is owed on that property (for example to a lender on a mortgage).
Very simply put, if the market value of a building in $300,000 and the owner still owes $110,000 on the mortgage, the owner’s equity is the difference of $190,000. When equity is 100%, it means the property is paid off and fully belongs to the owner.
A company’s equity on the balance sheet is the difference between the company’s total liabilities and the company’s total assets.
How to increase/build equity?
There are several factors that can increase the owner’s equity:
– The bigger the mortgage down payment, the bigger the starting equity is, when purchasing a property.
– With each mortgage payment made, equity increases. Extra payments made to apply to the mortgage principal increase equity further.
– Improvements contribute to increasing a property’s market value. This, in turn, increases the owner’s equity, provided the improvements are not financed through a loan. The amount of improvement equity is only truly determined at the time of sale of the property.
– Market value appreciation is beneficial, as well – if similar properties in the area are selling for higher prices, this positively affects the market value of all properties in the area and this reflects on owner equity.
How to reduce equity?
All the positive equity factors listed above can also work in reverse:
– By refinancing a loan/taking out a second mortgage, the principal of the loans taken out against the property increase, therefore equity falls.
– If there is extensive damage to the property and the loss cannot be covered by the owner’s insurance, equity falls. Similarly, deferred maintenance decreases equity: if the property is not kept from deteriorating over time, costs to make major repairs end up chipping away at equity.
– A decrease in market value automatically decreases equity.
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