Equity is one of those scientific sounding words that you’ll likely hear about when you borrow to buy a house, seek investment or bring in a partner for a business. But it’s not hard at all to understand what equity means. In a nutshell, it pretty much means the dollar or percentage amount of ‘real’ ownership you have in something.

Here’s a short video (4:05) with a quick and easy explanation of what ‘equity’ and ‘negative equity’ means.

With equity, there were two things you should remember.

How much in dollars someone owns, and then how much they owe. The difference is equity, their $ real ownership.

Let’s say you borrowed money - $250,000 to be exact to buy a house and that house is valued now at $300,000.

Let’s calculate your equity (we’ll not worry about interest and other real estate taxes to make the calculation simple):

House worth: $300,000

Debt: $250,000

The amount you put in: $50,000.

Your equity is $50,000 of the $300,000 house. That’s one-sixth. Your real ‘ownership’ is one-sixth of the house.

How about if you made a payment of $50,000 to reduce your debt? Let’s calculate the amounts again:

House worth: $300,000

Debt: $250,000 - $50,000 = $200,00

The amount you put in: $50,000 + $50,000 = $100,000

Now…your equity is $100,000 of the $300,000 house. That’s one-third. Your real ‘ownership’ is one-third of the house.

That brings us on to the accounting equation and equity in a financial report like the balance sheet (if you were looking at accounting).

Here’s a really basic example of a balance sheet.

Equity is assets (what the person owns) less what the person owes. If you total these all and take away what you owe from what you own, you get the remaining figure, if any of what you own. That… is equity.

Assets

Cash $5,000

Car $13,000

Liabilities

Student Loan $16,000

Equity $2000 (Assets LESS Liabilities)

You can have a situation of negative equity, when the value of something goes down. Let’s say your car was vandalized and now it is worth zilch (and you don’t have insurance).

Assets

Cash $5,000

Car $0

Liabilities

Student Loan $16,000

Equity -$11,000

Your equity here is negative because you owe more than you have.

Negative equity can happen and it was common during the United State Subprime Mortgage Crisis that happened during 2007 – 2010. You’ll see it when the worth of a property, say a house, falls below the amount you borrowed to get the house in the first place.

Let’s look at negative equity and the house that was once worth $300,000 is now worth $150,000.

House worth: $150,000

Debt: $200,000

The amount you put in: $100,000.

This now means you have $100,000 in negative equity. You owe more than the value of the house. Ignoring interest, taxes and fees, if you sold this house, you’d still have to pay the bank another $100,000 because the sale of the house wouldn’t be enough to pay your debt.

This is generally not a good situation to be in.

So that’s equity, just a jargon name to mean how much do you own ‘really’ (your financial interest) when you take away how much you still have to pay others.