I am a newbie and I have to say this site helps me understand a lot about RE that was a mental block in my head.
So can anyone really help me understand, what really is equity?
From what I read equity is principal minus payments. lately I have been running into a lot of sellers that would post an add saying " asking price 140k, property has 65k in equity. but when I contact the seller they say the property appraised at 205k and that the full morgage is 140k. so they are saying that the equity is the difference between asking price and appraisal. this is a load of crap isnt it? or did I miss something?
Equity is the difference between the VALUE of an item and the amount OWED on the item.
The hard part with real estate is determining what the actual “value” is. An appraisal reflects what the appraiser believes the value to be, usually based on an analysis of what like properties have recently sold for. The actual value is actually what a willing and qualified purchaser will pay for it. So, while an appraisal is often a good reflection of the value, sometimes no one will pay the “appraised value” for a property.
In your example, a property that has an appraised value of $205K and an asking price of $140 (just what the seller owes) could represent a good bargain (68% of appraised value) if the appraisal is accurate. But as you noted, it could be ‘crap’ if the appraiser is some sort of knucklehead…
Here is another example
Grandpa lived in the house for 60 years, Grandpa bought it for 27,000. Today the house is appraised or Valued at 100,000. Grandpa has payed for the house and owes nothing except property taxes . Grandpa has 100,000 in equity. Equity in this case is the value because Grandpa doesn’t owe anything for the house. hope this helps you out and not confuse you more.
Thomas
I still don’t think you quite have it. You said that the equity is the difference between what you paid for the property and what it is worth. That is true only before you make a payment on the principle of the mortgage. If you think about the example that Thomas79 made, then according to your definition grandpa’s equity would be $73,000 ($100,000 value minus the $27,000 that he paid). Equity is defined as value minus amount owed. Since he has paid off the mortgage, his equity is $100,000 ($100,000 value minus $0 that are owed). In the example that you gave, the seller says that you have $65,000 in instant equity because he was selling the property for $140,000 when it was worth $205,000 because he has an appraisal that says that it is worth that much. I would not trust this appraisal. I have ordered (and gotten) an appraisal based upon what a property would be worth after we had improved it. We were planning on updating and enlarging the kitchen, enclosing the garage, adding an additional large bathroom, repairing the hardwood floors and generally updating the entire house. We told the appraiser what we were going to do and she did the appraisal based on the work that we would do as well as the location and other amenities of the property. If the property you are looking at has had the property appraised the way that I ordered that appraisal, then you would not have a proper understanding of the value of the property as it stands now. I would recommend that you get a copy of the appraisal and read it. If you find that it mentions things that are not currently in the property, you would know how the appraisal was done. Just as a side note, this is a valid appraisal, but it is appraised upon future value.
Hi everyone!
I am also a newbie and just realized that I, too, had wrong understanding of what equity is… I was under impression that it would be equal to the amount of actual mortgage payments I’ve done towards the property. Silly me…
I am still not too clear on one thing. Since fair market value can go up or down, depending on surrounding environment (crime, development, etc), wouldn’t my equity depend on that too?
Example, if I bought a house and paid, say, $50.000 out of $250.000 and during that time surrounding area went down and house worth $200.000, did I just lose the equity or what?
Another question, if Grandpa ownes his house free and clear and has to pay only property taxes and he fails to do so… How does that affect equity?
You are correct in your statement that if the value of your property went down because of surrounding conditions, you would lose equity. Such might be the case if you bought in a community that had a very large employer that left or went bankrupt. In this case, you would have an excess of people wanting to sell their homes as compared with the number of people wanting to buy homes. Not a good situation to be in. In the case of Grandpa not paying his taxes, that is something that he would owe so it would be a decrease in equity. The difference is that taxes would be a minor reduction of the equity whereas a mortgage is usually a major reduction of equity.
WilsonTaylor,
Thank you for reply.
Is there anyway I could “predict” market conditions?
I mean, what are the signs of “going down” market?
Im interested in Atlanta’s market. The problem is, I’m not there so all I have to go by are numbers of houses sold and bought in the area, crime statistics and what real estate agent is giving me. From what I found out so far prices are pretty cheap there and many empty/abandoned homes. Would that indicate “down” market?
Also, I believe I heard from some real estate “gurus” that eventually real estate market always goes up if you wait long enough?
And, if I buy $150,000 house for $100,000, can I somehow use that equity to pay for closing and/or downpayment?
If you could predict the market, you could make more money than you could spend. It is true that markets go up and they go down, but in the long run the overall trend is up. It would take a major financial catastrophe like the
Depression to significantly lower the general price of housing. Now that I have said that, (and before I get clobbered by others) let me say that in a particular market, you may have overpriced housing that will decrease in value and take years or decades to again reach their former highs. If the property that you buy decreases in value by as much as 20 percent, it will require at least 5 years to climb back to that value. On the other hand, if you have bought at 20 to 30 percent below value, you are still not hurt. You might not make as much money or have to hold longer than you would like, but you could still sell if you had to. The person that has a problem is the one that has paid full retail and then lost 20 percent of value. Most people could not sell their house for 20 percent less than they paid for it. It takes 10 years to pay that much down on the mortgage.
As far as your question about Atlanta, if there are a significant number of boarded up houses, then it is a buyers market. At this point you can probably find more bargain properties to buy. In 5 years when Atlanta is booming again (based on cycles) then you could make some good money. The question is whether Atlanta will be booming in 5 years.
kdhastedt, thomas79 … that was simple enough explanation of equity for me to get in the door of starting to understand.
" An appraisal reflects what the appraiser believes the value to be, usually based on an analysis of what like properties have recently sold for."
this is why comps are necessary right? to determine the possible value of your property.
“Grandpa bought it for 27,000. Today the house is appraised or Valued at 100,000.”
So equity is the amount paid on mortgage plus the growth of value in the home. right? or appreciation
WilsonTaylor … now you rounded it out perfectly … and like shotoclay asked … equity is connected to a good RE market, depending on the neighborhood crime or the surrounding properties in the area. so paying the PITI is not enough.
So one should request a copy of appraisel and compare it to the property? Cash out is based on the apprasiel pretty much and how good of a deal you buy the property?
and if so how does one get cash out at closing? how do you pull the equity out of properties?
The example that I gave about the appraisal that I ordered for the property with all of the improvements we were going to make is an example of how to take money out of a property at closing. The appraisal was ordered for the bank that was going to loan the money. They would loan up to 80 percent of the appraised value after the property was improved. This was a rehab loan. The property appraised for $300k, so we borrowed $240k. The purchase price of the property was $180k, so we had $60k to remodel the property, less the points that the bank charged and closing costs.
Here’s the textbook answer, whether you’re talking about houses, cars, businesses, whatever…
Debt + Equity = Value
or
Value - Debt = Equity
If you know 2 of these numbers, you can solve for the third. With houses, we can usually get an idea of what the Value is based on comparable sales… this is basically what an appraisal is/does.
Debt is just the principal balance of any outstanding mortgages and other liens secured by the property.
The difference between the Value and Debt is your Equity.
For some reason equity and cash out always confused me. the first course I studied in RE was the Carleton Sheets no money down. and for some reason I thought when he discussed using wrap around mortgages, he was saying that the person’s equity was only the amount paid on PITI… so I guess from there I assume that that was the only thing equity was.
WilsonTaylor I really like how the cash out works, but the bank will use their own appraisers right? or will they use a previous appraisal from a third party. I mean I could get any appraiser to say the house is worth such and such, then get an 80% LTV on the ARV and come out getting 100% LTV plus cash in my pocket if I purchase property at 70% of the appraised value, is that right? wow my head hurts.
While it is true that you could get cash out and then not rehab the property, it would not be a good idea. These are typically rehab loans and will only be for about 1 year max. You will have to refinance after that and you may not be able to do so if you have not done the work. I would suggest that you do the work and then sell the house. That will put even more money in your pocket. If you do the work yourself, you might even be able to keep some of the rehab money.
ezrider,
Here’s yet another example that may help you to understand equity. Figuring equity is like figuring your net worth. Assets-Liabilities = Net Worth. Now apply that to figuring equity. Fair Market Value of house (asset) - Mortgage balance (liability) = Equity. Now plug in the numbers: $100,000 FMV (asset) - $60,000 mortgage (liability) = $40,000 (equity). Hope this helps.
Here is a good example of negative equity. If it confuses even more that is good because you still do not understand and may be doing deals like this.
I just bought a 31 unit building where the seller paid $300,000 several years ago. Today the loan balance is $150,000. Based on these two facts he may have equity of $150,000, but we do not know the value of the property today. It is almost vacant and full of crack dealers who do not pay rent and needs $100,000 in rehab. Now what is the value and equity? I bought it for $150,000 and at the closing table the seller paid $6000 to sell it to me. His equity at that second was - $6000.
After I am finished rebuilding the property and leasing it up the units appraised at $360,000 with the current market rents at $225. I borrowed $260,000 to buy and rehab the place thus giving me potential equity of $100,000. This is not potential profit on the deal but just the difference in what it may be worth and what I owe and it is not the amount I will net at the closing table. It is truly a hard figure to understand and the entire industry is build around it. Now another twist. I just raised the rents $50 per month increasing the value to somewhere around $460,000 in my opinion, at least that is what I am asking which will give me another $100,000 in equity.
Hopefully you can do deals like this instead of the negative equity deals. He was an absentee owner who got stuck with a building that was falling apart and could not get it repaired or chose not to.
Good luck in building some equity in your sandbox.
I was under impression that it would be equal to the amount of actual mortgage payments I’ve done towards the property. Silly me…