Equity is the amount of the house you truly own. It’s the difference between the balance you owe on your home and its market value. If you sold your house and paid off the bank, the value of your equity is what you’d walk away with.
Every month, a portion of your mortgage payment goes towards paying off the loan balance, and another portion of the payment goes towards interest costs. As you pay off the loan, you build equity: you owe a little less, which means you own a little more of your home,
If you live in a location where home values are increasing over time, your equity stake can also increase over time. Think of this as getting a windfall when you sell your home. This can also happen when you renovate your home – you can increase the value by the home improvement.
Many homeowners refer to their mortgage payment as a way of forcing them to save. You may not feel that you are saving money by making mortgage payments every month, but if you think about it, you actually are – you are building up the value (equity) of an asset you own. With your house, it isn’t cash in the savings account; it is equity in the home.
When you sell your home, your equity will translate into cash, and you can use this to pay towards your next home, allowing you to borrow less. You can also borrow money against the equity of your home, and the interest rates will be more favorable as your home will be used as the collateral.
So homeownership can be a useful way to increase your personal wealth for you and your family, since you’ll be building equity in your home as you pay off your mortgage.