Equity refers to ownership. Stocks are sometimes referred to as equity securities because when you buy stock you become a part owner of the company. If you pay cash for an item, you have 100 percent equity in that item. If you borrow money to buy something, like your house or a car, you split the ownership with the lender. As long as that item is worth more than you owe, you have positive equity.
Positive equity is commonly used to describe your home loan. Loaning money against a home involves a certain amount of risk to the lender, so mortgage companies want borrowers to come to the table with a down payment. Conventional mortgage loans typically require 20 percent down, but the government offers FHA and VA programs that allow qualified borrows to buy a home for as little as 3 percent down. The amount you put down when you buy a home usually represents immediate positive equity in the home.
Just making your regular mortgage payments every month might not be enough to build positive equity in your home. Outside market factors can play havoc with your equity. Your equity is not the difference between the purchase price of your home and what you still owe on it. Equity is the difference between your home's current value and what you still owe. If local real estate prices plummet, like they did when the real estate bubble burst in 2007, you could find yourself with negative equity in your home, even if you have never missed a payment.
Positive vs. Negative Equity
If you are like most folks, your home is your single largest asset, and represents a significant portion of your net worth. In a normal market, the value of your home tends to increase, and as you continue to pay down your mortgage, you build equity in your home. Your positive equity represents both wealth and additional borrowing power that you can tap, for example, to help pay for your kids college education. But if the real estate market turns south and your home's value drops, you could find yourself underwater on your loan, owing more on your loan than your house is worth.
While positive or negative equity is commonly used to describe real estate, it can apply to any item that you borrow money to buy. Your car might be a good example. If you paid sticker price for your new car and put 10 percent down, you might think you have 10 percent equity in your car. But according to car website, Edmunds.com, the average new car depreciates approximately 9 percent the minute you drive it off the lot, so you really only have 1 percent equity on average. By the end of the first year, your car is worth 81 percent of what you paid. Unless you're making some hefty car payments, you probably have negative equity in your car. Vehicles typically are categorized as depreciating assets that lose value over time.
- Los Angeles Times: Most Homeowners Still Faring Well, With Positive Equity
- Federal Trade Commission: Auto Trade-ins and Negative Equity
- Forbes: 2 Million Americans No Longer Plagued By Negative Equity
- CNN Money: Home Prices: Biggest Rise Since Housing Bubble
- Edmunds: How Fast Does My New Car Lose Value?
Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.