Equity has several meanings in the financial world. But simply put, it is the value of an asset—say, a business or a property— after all the debts or liabilities you have on the asset have been paid.
For instance, Judith took a loan for a cupcake business she plans to venture into. The loan amount was $20,000. She used the money to secure a place where she built her pastry shop. Her business became successful and she was able to pay off half of the loaned amount. If we were to compute then the value of her business, it would amount to $10,000. That is her equity.
Equity in property investing
In the context of property investing, equity is computed by subtracting any amount you owe on your property from the actual value of it. If the market value of your house, for example, is $400,000 but you borrowed money to buy that house and you still owe $250,000 to it, the amount of your equity is $150,000.
If suddenly the value of your house increases but you still owe the same amount, your equity will increase, too, even if you haven’t lessened your loan amount.
But the sure way to increase your equity (if the value of your home remains the same) is to reduce the amount you owe on your home. The more you continue to pay off the debt you have against your house, the more your equity increases.
Now why do we need to compute the equity? This is where the most commonly phrase “tapping into your equity” comes in. Essentially, equity is your asset. Thus, it is part of your net worth. You may own a property but if you still have a debt on that property, you do not totally own it unless you have completely paid off your loan. You have, however, equity on that property. And that equity, that value of share you have on the property, is what some investors use to purchase another property.
So how do you “tap into your equity”?
While still paying for a loan from your existing property, you can start to invest sooner in another property by harnessing the power of your equity. How do you do it?
Suppose you are eyeing on a property worth $450,00. You found a lender who will fund 80% of the total amount of property. That covers $360,000 of the amount of property. Now you still need additional $90,000 to complete the purchase. This is where you can tap into equity of your existing property to make the new investment to happen.
So like we mentioned above, your existing property is valued at $400,000 and you still owe $250,000 to it. That leaves you with $150,000 worth of equity.
Now you can only access 80% of your equity. In this case, you are allowed to use $120,000 from your equity but you will only be needing $90,000 to complete the purchase of the new property. Your equity covered the amount needed for you to invest in a new property, You were able to harness the power of having an equity.