Equity is Forced Savings

Equity is simply the difference in an owner's unpaid balance and the value of their home.  Amortization and appreciation contribute to the equity over time.  The equity is usually realized when the home is sold but it can also be accessed by a home equity loan or a cash out refinance.
Most people think that it takes years to significantly pay down a mortgage and they're partially correct.  A five percent interest rate on a mortgage takes approximately 20 years to pay down half of the original amount borrowed.
A mortgage is like a forced savings account because each payment is first applied to the interest due on the borrowed money but another part pays down the principal.  On a $188,175, 5%, 30 year mortgage, the first payment of $1,010.16 includes $226.10 principal reduction.  In the first year, the owner would have increased the equity in their home $2,776.24.


In the example below, the buyers paid $195,000 for a home that is estimated to appreciate only 1% per year for 7 years.  With a 3.5% down payment, the equity in the home at the end of 7 years would be $41,921.  55% of the equity would come from amortization; 29% would come from appreciation and 16% from the down payment.