In real estate business, equity denotes the property owner's stake in his or her asset. In other words, when we say a home owner's equity, it means the variation between the reasonable price of the property in real estate market and the amount due to the lender of a mortgage loan. Hence, the equity or stake of the home owner on his or her property goes up, even a little, with the repayment of each installment of the loan or the principal in a blended payment arrangement that requires periodic payment of identical amounts every time. It may be mentioned here that apart from the repayment of the fraction of the principal loan amount, the equity or stake of the home owner on his or her property may raise or decline depending on the rational market price of the real estate.
In fact, the equity aspect of a property may be somewhat compared with an elastic pie that is capable of getting bigger as well as lessening. Supposing the borrower's property (here it is the pie) is valued at $100,000 and the borrower has obtained a finance of $70,000 against the property, then the lender would own $70,000 or 70 per cent of the property or the pie, while the home owner's share would be 30 per cent or $30,000. In an event where the market value of the house is constant, each period payment made by the borrower on the principal loan amount will raise his or her stake or equity on the property, while the lender's hold on the property or share of the pie would be falling in the same proportion. If the borrower's total payment against the loan principal in the first year of the mortgage is $250, his or her equity on the house or share of the pie would go up to $30,250, while the lender's segment would reduce to $69,750 at the end of that year.
It is important to note here that the change in the market value of a property only affects the borrower - either his or her equity goes up or declines. If the market price of a property, earlier valued at $100,000, reduces to $97,500, the new equity of the home owner on the real estate will be $27,750, but if the worth of the same property goes up to $102,000, the borrower benefits as his or her new equity on the real estate increases to $32,250. In the first instance, the borrower's equity is in effect $97,500 less the $69,750 owing to the mortgagee, while in the latter case it is $102,000 less the unpaid mortgage of $69,750.
Having already obtained a mortgage of $30,000 on a property having a market value of $100,000, if the borrower requires more money for some specific requirements such as repairs or renovation of the home, he or she may avail second mortgages. For instance, if the mortgagor requires a loan of $5,000 on the equity of $32,250, he or she may go in for an 'equity loan' for the required amount. In such an event, the borrower is giving another share of the pie that is equivalent to $5,000 to a second lender from his or her equity of $32,250.
Now, consider this. When the market value of the property is $102,000 and the borrower has already arranged two mortgages amounting to $74,750 (the first mortgage worth $70,000, but reduced to $69,750 after the blended payment on principal for the first year, in the first mortgage and the second mortgage worth $5,000), his or her equity on the real estate has declined from $32,250 to $27, 250 after the first year of the first loan. The mortgagor will regain the fraction of equity given to the second lender only after he or she has repaid the loan of $5,000 along with the interest amount accrued on the amount. This will mean that the equity of the borrower is $32,250 as it was following periodic imbursements of the principal of the first mortgage at the end of its first year. The importance of collecting the loan amount in this situation can be best demonstrated using an example of an imaginary pole valued at $102,000 and where the first mortgage worth $69,750 is placed at the pinnacle following the second lender who has been granted equity worth $5,000. And the borrower is placed at the base of this imaginary pole with the left over share of the property equaling $27,250.
Here, it is important to note two things. First, the change in the market value of the real estate only affects the borrower and not the lender. And second, the frequency at which the borrower repays the principal amount of the loan to the mortgagee, his or her equity on the property improves at an identical pace. And this means that the lender's share on the pie declines at an equal rate.