What Is Equity? A Beginners Guide To Making Money Through Capital Growth
What is Equity? Equity in is simplest terms is the remaining value you have in a property that you haven’t yet tapped into. Many investors use equity to achieve financial freedom and you can too!
Equity is great because it can be used to build your property portfolio and it can even make you financially free.
In this post we will discuss in more detail what equity is, why capital growth (and thus equity growth) occurs, how you can access your equity when and if you need it and most importantly how you can get more equity.
What Is Equity?
As stated previously equity is the remaining value you have in a property that you are currently not accessing. The easiest way to calculate this is using the formula below
Value of the property (minus) Debt on the property.
So if you owned a property worth $450,000 and you had a mortgage of $300,000 then you would have $150,000 in equity ($450,000-$300,000).
Why Does Capital Growth and Equity Growth Occur?
Capital growth (and thus equity growth) can occur for a number of reasons.
Population growth – The more a population growths the more a property is likely to grow in value. This is for two main reasons, supply begins to outstrip demand and more people means more employment in the area.
Demographics – Demographic will determine the type of people in an area and the types of properties they are looking for. Suburban families will prefer a 3-4 bedroom house, thus these will be in demand. However, inner city professionals are likely to want something completely different and this a different type of property will be more valuable.
Economics – This is a review of how much money people earn and what they do for a living. People who earn more money will pay more in rent and more for houses, driving prices up. This is one reasons rents in mining towns can become so high…miners earn lots of money.
Infrastructure – The government creates the infrastructure. Things like roads, schools and hospitals all add value to an area. The more the government is investing in infrastructure in the area the better your chances of your property growing in value. (Eg. The government is investing a lot of money in the hunter region NSW at the moment, this is seeing house prices rise in certain areas)
Supply and Demand – When demand outstrips supply prices go up, because people are fighting over something rare. When supply outstrips demand prices go down because buyers/renters have more to choose from and can afford to negotiate. Living in an area where demand is greater than supply helps increase the value of your property. This is why mining areas in recent years have boomed, because there has been an influx of demand (new workers) but supply can’t keep up.
Quality of Your Property – A good quality property will obviously fetch more than a poor quality property. Bad quality properties can be difficult to sell and are often sold at a discount. A property near me was recently on the market for HALF the median house price of the area. However, it didn’t sell as it had major structural issues.
How Can I Access My Equity?
There are two main ways to access the equity in the property:
1. Take a loan out against the equity
Say you own a house worth $500,000 but you only have a $300,000 loan against the property. You effectively have $200,000 in equity.
You could go to the bank and borrow up to 80% of the value of the property. For a $500,000 house this would mean having a mortgage worth $400,000. This means you could access $100,000 of your equity TAX FREE straight away.
Obviously you pay the bank interest on this loan. However, if the loan is being used for investment purposes the interest fees can be tax deductible.
2. Sell the property and access the equity in cash
The other way to access equity is to sell the property and pocket the excess cash.
In our above example you sell your house for $500,000 and pay off your mortgage of $300,000. You are left with $200,000 profit (minus expenses). However, you have to pay capital gains tax on this profit and you no longer get any of the growth advantages of keeping the property.
Equity – One Of The Great Things About Investing In Property
Equity is one of the great things about investing in property. Over time as your properties grow in value your equity grows in value with them.
Over time you can draw on this equity and use it to fund more investments of you can even you it to fund your lifestyle.
There are many professional investors who are living off the equity that they gain from their investment properties, and thousands more have used equity to build a substantial property portfolio that fund their lifestyle in other ways.
Want to grow your equity – Read Get More Equity (blog post)