Definition of Equity
Equity is the net value of property, after deducting mortgages and other encumbrances from the fair market value.
Equity is the rough sum a home owner could be expected to obtain after selling the property for fair market value.
Example
Mr. McGillicuddy has a home with a fair market value of $250,000. He owes $125,000 on a first mortgage, $20,000 on a second mortgage. After subtracting the liens against the property, Mr. McGillicuddy has equity of $105,000 in the property.
Equity is important for a number of reasons. First, it is a main consideration in determining a person’s net financial worth. Second, equity is the basis upon which the viability of refinances or home equity loans such as lines of credit or second mortgages are assessed. Qualification for one of these mortgage products is partly based on the amount of equity that is currently available in your home.
For instance, a home may have a fair market value of $1,000,000, but if there is a first mortgage of $980,000, then there is only $20,000 in equity. According to current Canadian lending guidelines, a lender could not offer you a mortgage bases on this amount of equity. On the other hand, if the property is only worth $100,000, but only $10,000 is owed against the property, the property has $90,000 in equity and if all other lending criteria is met, a lender could offer you a mortgage for up to 80% of the value of this home.
Increasing Equity
Equity can be increased by two methods: Increasing the fair market value of the property or decreasing the amount owed on the property. Increasing the fair market value can include upgrading the property by renovating, landscaping etc. but is usually more of a change in the prevailing market, i.e. home values in the area increasing.
Paying down the liens against the property, and there by reducing the value of the debt against the value of the home, is in the control of the home owner. This can be accomplished by making extra payments on the mortgage loan, utilizing the mortgage’s pre-payment privileges or by reducing your current interest rate through refinancing. Lowering your interest rate can mean that more of your monthly payment to be applied to your principle, thereby increasing your equity faster. However, it is important to note that refinancing usually involves heavy penalties for breaking your current mortgage that may make this process futile if the desire is simply to reduce your mortgage and increase equity. In this case, it’s best to wait until your renewal date to make a change but be sure to take the time to shop for the best mortgage rate available to you.
At First Foundation, we can assist you in assessing the equity in your property and help you determine whether a home equity loan or refinance is right for you.
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