You buy a house for 100. Every month you pay the bank 1. After a while, you still owe 69. You sell the house for 120. The bank gets 69 and you get 51. You made 20!

Now if there’s an interest rate, you made less than 20, but the math there is harder.

I bought a house a while ago for 180,000 and I paid 1,000 every month on my mortgage. After 4 years in the home, I’d paid 48,000, but I still owed the bank 165,000. Ouch. That’s the interest rate. BUT I SOLD IT for 220,000! The bank gets 165,000 and I get to keep the 55,000 left over! I got all my money back, and I made 7,000. Very cool.

With a mortgage (or any other loan) your monthly payment goes to a combination of interest (profit for the lender) and principal (pays down the balance of the loan).

If I had a $200,000 mortgage and have paid $100,000 to principal since then, I have $100,000 in equity in my house.

If I sell my house, I still need to pay off my mortgage as the bank owns it. So (ignoring things like closing costs) if I sell that same home for $200,000, I need to spend $100,000 to pay off the remaining principal leaving me with $100,000 left over.

Equity is basically how much money you paid into buying the house, so you would get that amount back when you sell the house, since you don’t owe that amount to the bank anymore.

So say the house costs 100, and you paid 50 of the loan off, and then sold it for 100. Because you already paid 50, you only owe 50 on the loan (mortgage) (ignoring interest rates for simplicity). So of the sale, 50 goes to the bank, and 50 goes to you, like it’s your equity being returned to you.

Home equity is the difference between the amount you owe on a mortgage and the value of the house.

Suppose you borrow $200,000 to buy a house, and then you pay off $100,000 into the mortgage. When you sell the house you sell it at $250,000. You still need to pay off the mortgage so that leaves you with $150,000 that you can turn around and contribute towards buying a new house.

That $150k is “equity” that you can get out when you sell the home. As you pay down the mortgage it increases your equity, and as the value of the home increases over time it increases your equity.

Having equity in the home means it is expected to sell for more than you owe on the mortgage. It doesn’t “make” money. It means that if you sell the home, you will receive the difference between the sale price and the amount of money it will take to pay off the mortgage. It is important to know that if a real estate agent is used by either the buyer or the seller, the seller is expected to pay the real estate agent commission out of the proceeds as well.

Edit: If the house is expected to sell for more than you paid for it, then in theory you made money. But that is due to appreciation of the value of the home and not the only way to build equity. The other way is to pay down the principle on the mortgage.

Where is the new mortgage coming in?

I buy a house for $100,000 with a $100,000 mortgage. Five years later, I have paid $50,000 of my mortgage. But, the market value of my house also went up to $150,000.

At this stage, you have $100,000 of equity in the home because it’s worth $150,000 but you owe $50,000 on the mortgage still. Meaning, if you sold the house you would be left with $100,000 in your pocket.

Buy a house for $400k with 10% ($40k down) and $360k mortgage. Over 5 years, you pay down the loan to $300k owed. And the value of the home is now $500k. So when you sell for $500k and pay back the balance on your loan, you have $200k remaining as your equity. Your original $40k down payment, the mortgage principal you’ve paid, and the $100k gain in value.

So now, instead of $40k for a down payment, you have $200k down. You could put down 20% and still be able to get a $1m house.

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