What is equity?
Equity is the amount of the asset that the person owns net of any debt that is linked to the asset. We usually only refer to equity in relation to property and mortgages.
Equity is estimated by subtracting the outstanding mortgage attached to the property from the value of the property. For example if a property is estimated as worth $300,000 and the mortgage owing is $240,000, then the equity is $60,000.
In this case, if the property were sold for $300,000 the lender would be paid $240,000 and the owner would receive $60,000. But don’t forget that the owner is also liable for legal costs associated with selling and real estate agent costs as well (amongst other things). So the $60,000 would be reduced further.
The great thing about equity is that if the property increases in value over time, and you maintain payments on the mortgage, then the equity would increase. For example, if it were two years later and the property market had increased by say 6% per annum, then the property would be worth $337,080. The mortgage might have been paid down, or the balance might remain the same. Either way, the equity has increased from $60,000 to $97,080.
How do you access equity?
You can access the equity in a property by selling the property. But that attracts agent and legal costs and potentially tax liabilities too. Another way to access equity is to borrow against it. That way, if you have enough equity relative to the value of the house you could borrow more. Don’t forget, borrowing against this equity incurs cost, so if you decide to do this you need to ensure it is for a worthwhile reason such as consolidating some other debt, renovating etc.
What is enough equity – what is an LVR?
The LVR is acronym for the ‘Loan to Value Ratio’. It is commonly called the LVR by finance brokers and lenders. It is a ratio achieved by dividing the amount of the mortgage owing on the property by the value of the property as a percentage. Using the example above, the initial LVR was 80% – that is $240,000 (Loan balance) over $300,000 (Value of property) x 100 as a percentage. The growth in property value from $300,000 to $337,080 improves the LVR to 71.2% – that is $240,000 (Loan balance) over $337,080 (Value of property) x 100 as a percentage. The lower the LVR, the greater the chances of accessing more equity.
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