What is Equity?

Because this is a personal finance blog, I feel it's important from time to time to discuss, explain, or define some of the more arcane or vague technical jargon that we encounter.

For one, it discourages people from investing because it somehow magnifies how much we "don't know" yet.

Second, it creates confusion or uncertainty. We hear something and we say "What is that?" with matching blank looks, furrowed brows, and head scratching. And then we're unsure what to do next.

So for today, we will tackle one of the more common terms we hear: Equity.

So what is Equity? Equity is... wait fot it... ownership. tada!

If that's what they meant, why didn't they just say that, right? Sort of makes you want to kick someone...

But being a finance/accounting term, it's not just ownership.

Take your car or house, for example.

When you buy it, it's yours and you can do with it what you want. Even if you took out a loan to get it. In other words, you own it.

But if you haven't paid off the loan yet, you don't have "equity" on it. Sort of like it's not yours just yet. If it's worth 500k, and you just started paying a loan totaling 520k, you actually have "negative equity".

If it's fully paid, and assuming it retained its value, then you have full equity or 500k in equity. If you're still paying it off, then your equity is the value (500k) minus how much you still owe (say200k; so you have about 300K in equity).

So that's pretty much the reason for the technical jargon. It's meant to help keep track of ownership.

Stocks are usually termed as equities because they represent ownership in a company.

It's also used in real estate (ex: Home Equity Loan - borrowing against the house's value).

But whatever it's used for, the principle is the same: Equity = Value - Liability.

If you have other terms you'd like to see explained or defined here, just drop a comment below. I don't have a PH.D. or anything, but I'll give it my best shot.

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photo credit: kevin dooley via photopin cc