Equity

Key Takeaways

• Equity is current market value minus everything owed against the property, not the amount the owner originally paid.
• Two separate forces build equity: paying the loan balance down, and the property gaining value.
• Equity turns negative when the balance owed is larger than market value, a position commonly called being underwater.
• In Washington the homestead exemption protects the greater of $125,000 or the county median sale price of a single-family home in the preceding calendar year (RCW 6.13.030).

What It Means

Equity is the part of a property's value the owner holds free of debt. Take today's Market Value, subtract every loan and lien recorded against the property, and what remains is equity. A house worth $565,000 carrying a $359,466 loan balance holds $205,534 of it.

Two forces move that number, and keeping them apart matters. Every principal payment on an amortizing loan cuts the balance and lifts equity by that amount, slowly at first and faster each year as less of the payment goes to interest. Appreciation works the other side of the equation by raising market value, and market value can fall as well as rise. A down payment is simply equity bought in a single lump at closing.

Equity is a position, not cash. Converting it to money takes a sale, a refinance, or a second loan such as a home equity line of credit. It can also run negative. When the balance owed exceeds market value, the owner cannot sell without bringing money to closing or persuading the lender to accept less than full payoff.

How It Works in Washington

In Washington, equity is what the homestead exemption protects. RCW 6.13.030 sets the exemption at the greater of $125,000 or the county median sale price of a single-family home in the preceding calendar year, with the county figure taken from the Washington Center for Real Estate Research or a successor designated by the Office of Financial Management. Because that median differs by county, the protected amount is not one statewide number, and it moves each year.

The protection has a limit students miss. RCW 6.13.080 makes the exemption unavailable against debts secured by mortgages or deeds of trust on the premises that were executed and acknowledged by the owner, so it does nothing against the very lender the owner signed the Deed Of Trust for. The homestead exemption shields equity from other creditors, not from the purchase loan.

Washington also treats equity as something that can be stolen. Chapter 61.34 RCW defines an act of equity skimming, which includes buying a dwelling on a representation that payments on the existing mortgages or deeds of trust will be made, then failing to make them within two years of the purchase while diverting value by collecting rents or removing fixtures. The chapter exists because a homeowner's equity is often the largest asset they hold.

Example

Marisol buys a Tacoma house for $480,000 with 20 percent down, so she signs a $384,000 note at 6.5 percent for 30 years and starts with $96,000 of equity. Five years and 60 payments later the balance has fallen to $359,466, and comparable sales put the house at $565,000.

Her equity is $565,000 minus $359,466, which is $205,534. Split it and the story is clear. $96,000 came from her down payment, $85,000 came from the property gaining value ($565,000 less the $480,000 she paid), and only $24,534 came from five years of principal payments, because early payments on a 30-year loan go mostly to interest. Those three pieces add back to exactly $205,534. Had the market moved the other way and the house been worth $340,000 instead, her equity would be negative $19,466 and selling would require her to bring cash to closing.

Common Mistakes and Exam Traps

• Equity is measured against current market value, not against the original purchase price and not against the assessed value used for property taxes.
• Equity is not the same thing as the down payment. A down payment is the equity an owner starts with, and equity keeps moving after closing.
• Subtract every lien secured by the property, not only the first loan. A second mortgage or a home equity line reduces equity as well.
• Washington's homestead exemption gives no protection against the deed of trust the owner signed and acknowledged (RCW 6.13.080); it protects equity from other creditors.