The concept of equity plays an important role several industries, such as real estate, business management and venture capital. The most common use of the term is in real estate, to describe the estimated value of a homeowner's interest in a property after deducting liens. In all these settings, understanding what causes equity to change is crucial if you want to maximize the return on your investment.
Fair Market Value
The fair market value of a property is the basis for calculating your equity. The fair market value of a property is not necessarily the price you paid for it. It is the price an informed and willing buyer would pay and an informed and willing seller would accept. If a property you own outright had a fair market value of $200,000 and its fair market value later increases by $10,000, your equity rises by the same amount.
Property Tax Assessment
The assessed value of a property is the value used for tax purposes. Unlike fair market value, it is not determined only by supply and demand. The assessed value is based on several other factors, such as how much income the property can generate, the cost of replacing the property, and the level of assessment chosen by your locality. The level of assessment can change depending on the locality's revenue needs. The assessed value of a property is also used as a factor to determine its market value, so any changes in assessed value affect the owner's equity.
Your equity interest in a property is determined by deducting any encumbrances or liabilities on the property from its market value. Encumbrances include mortgages, home equity loans, contracts for deed and other liens that use the property as a security. For instance, if the market value of your house is $200,000 and you have a $50,000 mortgage, your equity is $150,000. However, if you take on a $20,000 loan that uses your house as security, your equity drops to $130,000.
Another important factor that can cause your equity to change is the percentage of ownership interest you have in the property or company. For example, if you and your spouse share equal ownership interest in a home, your equity on the home is 50 percent of its fair market value after deducting encumbrances. However, if your spouse were to die and you became the sole owner, your equity would double.
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