Equity is one of those financial words that is thrown around sometimes by financial professionals. It might sound like a ten-dollar word, but it’s really not too complicated. Plus, it is really important for you to understand what this is, and how it affects you and your financial life. Let me explain.
What is Equity?
Equity is simply the amount of ownership that you have in an item.
The formula is pretty simple.
The amount that the item is worth
– The amount that you owe on the item
= The equity that you have in that item
Pretty much everyone knows how debt works. You borrow some money to purchase a house, a car, a college education, etc. and then you have to pay it back over time.
When you are making payments on that debt each payment will have some of it that goes to interest and some of it that goes to principal.
The interest that you pay is the cost that the bank charges you for borrowing their money. And the principal is the amount that you pay that actually reduces the amount that you owe.
For example, If I owe $10,000 on my car that has a payment of $500. Of that payment $400 is principal and $100 is interest. After I make my payment, I will owe $9,600 on the car.
$400 of my payment went to reducing the amount owed and $100 went to the bank’s profit.
Let’s say that the car is worth $15,000. That means that BEFORE I made my payment I had $5,000 in equity. And AFTER I made my payment I had $5,400 in equity.
The car is worth $15,000
I owe $9,600.
$15,000 – $9,600 = $5,400 equity.
How Equity Benefits You
This benefits you because the more equity you have in an item, the more ownership of that item that you have.
If you have a house that is worth $300,000, would you rather have $100,000 ownership or $150,000 ownership?
Of course, $150,000! That means that you would have more ownership in that house than the person who has only $100,000 in ownership in it.
The nice thing about equity is that each month that you pay on a house, car, etc. you gain a little more ownership in it.
Final Thoughts
Equity is really important to understand. You don’t have to be a mathematician to understand it. But you really should have an idea of how much equity you have in the items that you own.
I am here to help you!
You can do this!
Until next time!
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