Equity Explained

Equity is the value of an asset after paying off any related liabilities.

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When you’re ready to cash in on an investment, perhaps by selling a home or business, you’re banking on it being worth more than any outstanding debt owed on it. The money you hope to pocket after the sale is called equity.

What is equity?

Equity is the value of an asset after paying off any related liabilities

. It represents the owner’s interest in the asset, and is calculated in both personal and business finance to gauge the health of an investment. Written as an equation, Equity = Assets - Liabilities.

The basics of equity

In simplest terms, equity is money — your money — inside another asset like a car, a home or a business.

  • Equity is tied to ownership. No matter the type of asset, equity represents the value the owner would keep after the asset was sold and all liabilities were covered.

  • In business, equity appears on a balance sheet. It spells out the owner’s or shareholders’ current stake in the company. It’s also used to determine if the company is in a healthy financial position

    U.S. Small Business Administration. 5 Things to Know About Your Balance Sheet. Accessed Mar 16, 2022.
    .

  • Equity increases as the asset's value increases, liabilities are reduced, or both.

  • It’s also possible to have no equity. If liabilities exceed the value of the asset, the owner has negative equity

    Consumer Financial Protection Bureau. What is Negative Equity in an Auto Loan?. Accessed Mar 16, 2022.
    . In that case, they could wait to sell the asset until liabilities are reduced or sell the asset at a loss, meaning they're selling the asset for less money than they paid for it.

Why equity matters

If you have equity in your car, it’s about as good as cash if you decide to trade it in for a new vehicle. If you own your home, any equity you have in the property would come back to you if you opted to sell

Federal Trade Commission. Home Equity Loans and Home Equity Lines of Credit. Accessed Mar 16, 2022.
. That could help cover the purchase of your next residence.

Equity in a home also can be used as collateral to borrow money. Common examples include a home equity loan or home equity line of credit.

When it comes to other assets purchased for the primary purpose of building wealth, such as stock in a private or public company

PEI Media. Private Equity: A Brief Overview. Accessed Mar 16, 2022.
, equity shows whether the investor has been successful.

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Home equity and home equity loans

Home equity grows as you pay down your mortgage or local housing prices go up (or both). For example, if your home is worth $250,000 and you owe $150,000 on a mortgage, the equity in your home is $100,000. If the value of your home increases to $300,000, then your equity rises to $150,000.

Homeowners may tap into this value by way of a home equity loan. Using their home's equity as collateral, borrowers can access funds for a variety of uses, such as paying for home improvements, consolidating debt or covering emergency expenses at a lower interest rate than credit cards

U.S. Bank. Home Equity Loan. Accessed Mar 16, 2022.
.

But it can be a risky move: If the borrower can’t repay the loan, the lender can foreclose on the property

Rocket Mortgage. Home Equity Loans: A Complete Guide. Accessed Mar 16, 2022.
.

Private equity

Private equity is a cash investment in a private business in exchange for a share of ownership — or equity. It’s considered an alternative investment and is grouped with real estate, private debt, collectibles and other investments that aren’t stocks, bonds and cash

Harvard Business School. 7 Types of Alternative Investments Everyone Should Know. Accessed Mar 16, 2022.
.

Private equity investments tend to be riskier than traditional investments.

The term can refer to a variety of deals involving private companies. A common target for private equity investment is a struggling or stalled company that has potential for future growth. Often called a buyout, this type of deal involves taking over the company to turn it around and make it profitable

Harvard Business School. How to Analyze Private Equity Performance. Accessed Mar 16, 2022.
.

Another example involves young companies, also called startups. These businesses may not be able to get a traditional loan. Instead, if the business idea is promising, high net worth individuals or venture capital firms may invest funds that would get the company up and running

Minority Business Development Agency. Equity Financing. Accessed Mar 16, 2022.
.

No matter the form it takes, private equity investors aim to get a high return on their investment when the company is sold or debuts on a public market, or when the investor sells their stake at a profit

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