What is equity? It’s one of those words we hear a lot, but it’s not always clear what it means. If you’ve ever wondered what equity actually is and how it works, here’s what you need to know.
Compare stocks and shares ISAs
If you’re planning to open a stocks and shares ISA, choosing the right platform is important. To help you narrow down the choices, we’ve created a list of some of the top stocks and shares ISAs.
What is equity?
In short, it means ownership. So, if you own something valuable, like a house, you have ‘equity’ in it.
But what does it mean to have equity? Why don’t we just say we own something? Well, because although it means ownership, it’s a little more complicated than that.
Think of equity as a measuring tool. It allows us to:
- value how much our ownership is worth
- determine how much we can sell something for
In other words, equity matters because it’s more than ‘just’ ownership. It’s a financial tool. And although it means slightly different things depending on the context, equity always comes down to financial value.
Here’s how it works in different contexts.
This means how much of the property you own outright. So, if you’ve got a mortgage, you don’t truly ‘own’ the whole property. Your lender has an interest in the property until you pay off the home loan completely.
Does this mean your lender owns part of your property? No. It just means that if you sold your house tomorrow, you’d need to use some of the sale proceeds to pay off your home loan.
- When we talk about home equity, we’re talking about how much your ownership is worth (remember, it’s all about value).
- Take your home’s value and deduct any mortgage liabilities – that’s your equity.
Here’s an example:
- You bought a house for £100,000 and paid a 20% deposit (£20,000).
- Next, you took out a mortgage for the remaining 80% (£80,000).
- Although the property is worth £100,000, you only officially ‘own’ 20% of it.
In this example, your equity is £20,000. The number increases over time as you pay down the mortgage, and you can use the value in your home to finance other projects like home improvements.
Shareholders’ equity means your company’s ‘book value’. In other words, it’s the value remaining when you deduct debts and liabilities from the company’s assets.
You can find the book value on the balance sheet.
Are you making these 3 common investing mistakes?
These all-too-common investing errors could lead to missing out on the long-term wealth-building power that shares can hold….
To help you better understand these pitfalls, how you could avoid them and move forward on a path to wealth-building, we’ve created a free report, “The 3 Worst Mistakes New Investors Make”.
Just enter your best email below for instant access to your free copy.
- Liabilities include debts, monthly payments and utility bills.
- Assets include land, property and equipment.
Here’s a simple example to make it clearer:
- Your coffee shop has £10,000 in assets and £7,000 in liabilities.
- The shareholders’ value is £3,000 (£10,000 – £7,000).
Aside from shareholders’ equity, the term can mean a number of things in the business world.
Equity in stocks
If you own stocks in a company, you own a portion of it. So, if you’re an investor and you have stocks, you have equity in that company. You can either own ‘common’ stocks or ‘preferred’ stocks (stocks with additional benefits like voting rights).
How do you determine stock equity? It’s essentially the cash value you could sell the stock for on any given day. Again, it’s a fluctuating value.
Think of personal equity as a combination of everything above. It’s the sum of all of your assets. So, it includes:
- home value
- ownership interests in a company
- income from stocks and shares
You calculate the sum by subtracting any debt or financing you used to purchase these assets.
How can you increase your personal equity? You could, for example:
- invest money
- buy stocks and shares
- invest in a startup
The best part? You can grow your wealth over time.
What is equity? Well, it essentially puts a price tag on how much your ownership is worth. It’s an invaluable tool for calculating how much you can sell assets for, and, more importantly, it’s something you can grow in the long-term.
Some offers on MyWalletHero are from our partners — it’s how we make money and keep this site going. But does that impact our ratings? Nope. Our commitment is to you. If a product isn’t any good, our rating will reflect that, or we won’t list it at all. Also, while we aim to feature the best products available, we do not review every product on the market. Learn more here. The statements above are The Motley Fool’s alone and have not been provided or endorsed by bank advertisers. John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. The Motley Fool UK has recommended Barclays, Hargreaves Lansdown, HSBC Holdings, Lloyds Banking Group, Mastercard, and Tesco.