Definition: The amount of ownership that holders of an investment or asset really have in it. It is calculated by taking the market value of the investment or asset and subtracting the amount of money that is still owed on the loan taken to buy it.
Example: Five years ago, REIC Corporation bought a $100 million office building in a big city. At that time, it borrowed $25 million to help afford the purchase. Its been gradually repaying the loan, bringing the amount owed down to $20 million. REIC’s equity in the building is $100 million – $20 million, or $80 million.
Investeach explains: In the same way we can calculate the actual ownership of a specific asset or investment, we can calculate the equity of an entire corporation by adding up the value of everything it owns (ie: its Assets) and subtracting everything it owes (ie: its Liabilities). The result is called Shareholder’s Equity.
One of the reasons that a housing crisis began in late 2007 was that banks got into the habit of lending up to 100% of inflated home values to home buyers. Imagine that a bank lends a homebuyer $250,000 so he can purchase a $250,000 home. How much equity does the owner have in the home? $250,000 minus $250,000 is $0! Zero, nothing, nada.
Now, imagine that over the course of the next year the home’s value drops down to the $200,000 it was worth before home values boomed. What is the homeowner’s equity now? $200,000 – $250,000, or -$50,000. What would you do if this was your home? With home values falling and the economy in crisis, millions are faced with this same question. Some are deciding to walk away, to leave the home and send the keys back to the bank. Their reasoning? Why work hard to pay off a $250,000 loan only to own a home worth $200,000?
What about their moral obligation to pay? They did after all sign their names to promise to repay their loans. Well, forget all that. It’s strictly a business decision. Who can blame these homeowners? They may have taken their lead from real estate corporations who have also very publicly done the same thing. Click here to read about the most prominent example.
Riddle me this:
1. How do we calculate the equity a person or company has in an investment or asset?
2. Why might a person who owns a bunch of properties not be as rich it seems?
3. How much equity will a person have in a home if the bank loans him 100% of the purchase price?
4. What are many homeowners doing who find themselves with negative equity in their homes?
Also known as: Net worth