Equity is simply the amount of ownership value a homeowner has in the property. Equity is computed by subtracting the total of the unpaid mortgage balance and any outstanding liens or other debts against the property from the property's fair market value.A homeowner's equity increases as he or she pays off the principal balance of the mortgage and/or as the property appreciates in value.When a mortgage and all other debts against the property are paid in full, the homeowner has 100 percent equity in the property.

Equity exists in conjunction with the loan-to-value (LTV) ratio.The LTV ratio is an expression of the value of your property compared to the amount of your loan.You can determine your LTV by dividing your loan amount by your property's value or selling/purchase price, whichever is lower.

For example, let's say you buy a $200,000 home and make a $40,000 down payment with your own money, and cover the remaining $160,000 with a mortgage.Dividing $160,000 by $200,000 gives you a loan-to-value ratio of 80 percent and equity of 20 percent, or $40,000.

If you decide to sell your home at a later date, your equity will be determined based on the fair market value of the home less the amount you still owe on the home. So, continuing with the example above, let's say you live in your home for five years after purchasing it.During that time, you make monthly mortgage payments that reduce the outstanding balance of your mortgage loan by $5,000, from $160,000 to $155,000.In addition, during that five years the value of your house increases, and you are able to sell the house for $220,000.Because you still owe $155,000 on the mortgage, your equity would be determined by subtracting $155,000 from $220,000, which would be $65,000.After you subtract other costs, including the commission paid to a real estate agent to help you sell your home, you could use this equity to make a down payment on your next home.

Conversely, your equity may decrease if the value of your home decreases after you purchase the home.If, for example, instead of increasing to $220,000, the value of the home in the example above decreases to $180,000, your equity would be only $25,000 ($180,000 less $155,000 owed on the mortgage loan).The possibility that your home's value may decrease is discussed below.