Equity. What is it and how to calculate it?
Equity is cool. The more equity you have, the richer you are! It’s not some mythical thing and it can grow magically without you knowing. It can also reduce without you realising as well.
So what is it? Well the accountants say it’s Assets minus Liabilities equals Equity! In business, it's the value of the parts of the business minus the loans against them, which equals the equity.
But in terms of your home, it’s the amount of the property that you actually own, which is the property value minus your current loan. That's your equity.
So while you're working hard everyday and doing things in life, your equity can grow as the value of your home increases in the market. It can also grow as you pay off you loan. And if both of those things happen at the same time, your equity can grow faster! Of course, this scenario assumes house prices are rising, and while they historically have shown they do in the long run, the market can fall as well as rise. In that scenario, your equity can grow more slowly or even shrink.
So, because property prices (and therefore values) can fluctuate, lenders like to put in a bit of a buffer between the value of your home and what they’ll lend to you. Which is a good thing, because it is not just a buffer for them, it’s also a buffer for you. The last thing you want is to buy a home that is lower in value one year later with a loan that is higher than the value of the property. This is called negative equity and it ain’t good - at least not in the short term.
So how do you calculate your equity?
Well, it’s like this: If your home is worth $800,000 and your loan is $360,000 then you have $440,000 equity or 55%. However, for a bank we take 80% of the $800,000, which is $640,000, then minus your loan of $360,000, meaning you have $280,000 in available equity or 43.75%. So there's that buffer.
Good things can happen with equity. Sometimes you can use this equity to consolidate some personal debts; sometimes you can use it to for investing; but it is most commonly used to buy a bigger home or buy an investment property.
Of course, you need to be able to afford a bigger home (and a bigger loan) or an investment property. So try using our affordability calculator or contact HoLo.
If you’d like us to crunch some numbers with you, book an appointment or contact us