IN THE WORLD of personal finance, equity means ownership. This article considers the equity that an investor may have in real property, land and building(s). The investor’s equity is a measure of his part-ownership in the property.
In buying real property, usually the amount that you pay down on the property represents your equity in that property at the time of purchase. For example, if you are buying a residence worth and being sold for $200 000 and you pay down $40 000 then your equity is $40 000 or 20 per cent of the value of the property. The mortgage value would be the balance of $160 000.
Over the years, you will build up additional equity in two main ways – one, by the gradual repayment of the loan, and two, by the growing value of the property.
Say, that ten years later, the same residence is now worth $240 000. By that time, you have repaid $45 000 of the principal. Then, your equity would have moved to $125 000, which is then 48 per cent of the prevailing value of the property.
This rapid growth in equity is due to the increase in the appraised valued of the property as against the principal balance of the mortgage. The balance on the mortgage would be the original principal less the repayment portion of the mortgage attributed to reducing the principal over the ten-year period.  Remember that each mortgage installment pays an interest portion plus a principal repayment portion. Â
Meanwhile, the property would have increased in market value from $200 000 to $240 000 over the same period.
This phenomenal growth in equity has given rise to home equity loans and lines of credit. The equity which a family builds up in its home may be used as collateral for a further loan. Some creditors are willing to lend based on up to about 90 per cent of the accumulated equity in a home as collateral towards the education of the children or for home improvements.
Lenders tend not to look kindly on home equity loans for minor or everyday expenses. Home improvement loans tend to meet special favour. This is because, say, by modernising the kitchen or bathroom of one’s home, the value of the home tends to jump commensurately. So, in a way, the mortgagee who extends a home equity loan for home renovations is also looking after the investment.
A home equity loan is quite attractive as it is relatively easy to negotiate and the interest rate on the loan tends to be lower than other means of financing. In addition, interest paid on loan financing for repairs to one’s residence is tax deductible up to a given limit.
There can be some danger in using the equity in one’s home for collateral. Default on the home equity loan can lead to foreclosure on the property even if the first mortgage is current. In addition, if the value of your property falls for whatever reason, the loan balance still remains the same.
This example of equity growing for a mortgage transaction applies to any other type of loan.
Your equity is the measure of your ownership of the property secured as the loan is repaid. When the loan is fully repaid, your equity is 100 per cent and you then fully own the property. In the case of real property, full ownership entitles you to take possession of the property deeds.
