Welcome to a new expansion of Real Estate IQ’s glossary! Today, we’re diving into a much-repeated word: equity. If you work with off market properties or at least attended one of our workshops, you surely know that equity (and the equity percentage) is one of the most relevant columns in our spreadsheets. It can help real estate investors determine whether a property is an excellent investment opportunity – and some even discard homes solely because of this number.
But what is it? Why is it so important? Well, we’re about to find out! Join us while we answer those questions, and learn how it works.
What is equity?
Home equity is the actual property’s current market value less any liens attached to that property. Or, in other words, it’s the difference between the market value of a home and the amount its owner owes the lender who holds the mortgage. Therefore, it can fluctuate over time because of the mortgage payments or the updates in the property’s value.
For example, if the market value is $100,000 and the owner owes $75,000 on the mortgage, the equity is $25,000 (if the property sells for its market value, of course). The bottom line, it is the portion of the property its owner actually owns.
How does equity work?
As we mentioned earlier, it can fluctuate. There are ways in which people can either build it or lose it over time. Among the reasons for the first one, you can build it by:
- Paying the mortgage – Every month that you pay, you own a bit more of the property.
- Improving the property – Upgrading the home, adding rooms or features, and even spending some money on cosmetic arrangements can increase its market value.
- Making a larger down payment – The more you pay in advance, the less your mortgage will be.
On the other hand, these are some of the things that can make a property lose equity:
- Refinancing the mortgage or adding new ones.
- Property deterioration.
- Changes in the economy and the local real estate market.
As you can see, some of the variables depend on homeowners, but others rely on external factors. It’s vital to notice that changes in the economy and the real estate market could also positively impact on this variable. Perhaps there’s a higher demand, or the property is located in an up-and-coming neighborhood.
To sum up, this is quite a critical number for real estate investors. If you work with off market properties, it can quickly tell what percentage of the property is owned by the distressed seller. Therefore, you’re in a better place to decide whether to go for that property or find another one.
In general, the more equity a property has, the easier it could be sold. Thus, if you build more of it, you’ll see a higher return on investment. Though it’s not the purpose of this article, it’s helpful to know that it can be used for other purposes, as well, like purchases or loans.
Disclaimer: The blog articles are intended for educational and informational purposes only. Nothing in the content is designed to be legal or financial advice.