Financial Dictionary -> Investing -> Equity

In real estate equity refers to how much "real" value is tied up in the house, which the owner actually owns outright. In other words how much of the house they own in comparison with how much is still left outstanding in the mortgage.

For example if Bob's house is worth $150,000 and he still has $50,000 left to pay on his loan then there is a $100,000 worth of equity tied up in the home. If he then sells the home for its $150,000 worth, fifty of it would go to the mortgage lender and he'd keep the $100,000 equity. Because sale price is always a prediction, using the figure of what a house is valued at isn't always accurate when calculating its equity. Because of this we call it the "fair market value" of the house.

Some homeowners opt to take out home equity loans, which is simply a loan where the equity of the home at the time is used as collateral to secure the loan for the lender (i.e. if the loan isn't paid back then the home is sold and the equity covers the loan repayment).

Although equity is not truly in the owner's hands until the house is sold, there are methods of "home equity management" that can utilize this tied up money to generate profits. Because the equity is tied up in the home it doesn't earn interest, so some people like to take out home equity like loans and use this money to invest, hopefully earning enough off the investment to repay the loan interest rates, with enough left over to have made a significant profit.

Despite this theory homes often appreciate (increase in value) over time, meaning the equity does gradually increase.

For example again if Bob's house was worth $150,000 at purchase price and he's paid off $50,000 he has an equity of $100,000, but the appreciation may be $20,000 so his equity has really increased because the house can sell at $170,000, which is more than he originally purchased it for.

If looking to utilize home equity it is important to seek out professionals for guidance.