What is Equity?
For many who are buying or selling a home for the first time, the terminology used throughout the process can be confusing. One word that may come up frequently is “equity.”
- What is Equity?
- How Does Equity Work?
- How Important is Equity?
- Can You Build Equity?
- Can You Lose Equity?
Equity is the amount of interest an owner has in their home. If you were to sell your home today, it is the amount of money you would receive after paying off any outstanding mortgage debt on the home. Here’s a simple example:
If the fair market value of your home is $400,000 and you owe $150,000 on the mortgage, your equity in the home is $250,000.
But equity can be fluid depending on several factors. Keeping an eye on your equity and learning more about it is important. While losing equity is possible, you can take actions to build your equity and see a better return on your investment when you decide to sell your home.
How Does Home Equity Work?
Your home equity is basically what you would earn if you were to sell the home and repay your mortgage. Of course, you would also have to pay off any second mortgage. When you own the home completely with no debt, you have 100% equity, or full ownership.
The costs of selling your home reduce your equity somewhat. For example, you sell your home for $400,000. Certain obligations are subtracted from that amount, such as:
- Remaining mortgage debt
- Property taxes
- Agent commissions
- Title charges
- Closing costs
The basic transaction would like something like this:
$100,000 remaining mortgage
$14,000 agent fees
$8,000 title, sales tax, closing costs, etc.
$264,000 total net equity
Can You Build Equity?
Homeowners can build equity by reducing the amount of debt owed toward the property and increasing the home’s value. While it’s true that real estate mostly appreciates in value over time, this isn’t always the case. You should be proactive in raising your home equity as much as possible. Here’s how.
Pay the Mortgage
Every mortgage payment you make reduces your debt and increases your equity. There is typically a balance of how much of your mortgage payment goes toward interest and how much goes toward principal debt; more is applied to interest early in the mortgage. But every bit of extra you pay goes directly to reducing the principal, depending on your loan type, allowing you to pay off the loan early and save on interest.
Consider this: as little as one extra mortgage payment per year can reduce a 30-year mortgage term by five or six years and save hundreds or even thousands of dollars in interest.
Upgrades and improvements you make to your home can increase its market value, and therefore, your equity. Some improvements are worth more than others. For example, if you invest $20,000 into kitchen renovations (especially without a home equity loan) you can increase your home’s market value by as much as $50,000.
Other improvements that can raise your home equity include:
- Adding a pool
- Finish the basement
- Add a room
- Add a bathroom
- Remodel bathrooms
- Install hardwood flooring
- Add an attached garage
Can You Lose Equity?
Your home equity can also fall. Taking out a second mortgage or refinancing your existing home loan will decrease your equity. Failing to keep up on home maintenance and allowing your home’s condition to decline can also lower its value and your equity. Even market conditions can change, or the value of your home’s neighborhood, and lower your home equity.
Want to know more about the equity in your home? Contact Jeff Cook Real Estate and talk with a real estate professional about equity and other matters relating to your home.