What Does Equity Mean in Real Estate?
Home Equity Is a Powerful Thing. Here's How to Safeguard Yours.
Equity is the difference between the market value of your home and the amount you owe the lender who holds the mortgage. Put simply, it’s the amount of money you'd receive after paying off the mortgage if you were to sell the home.
Here's a simplified example: The fair market value of your home is $200,000 and you owe $150,000 on the mortgage. Your equity is, therefore, $50,000 assuming you sell the property for fair market value.
You Might Not Get All Your Equity Back
Selling a home doesn’t come for free. So even if your equity stake is $50,000, as in the example above, it’s unlikely you’ll actually pocket that whole $50,000 once all is said and done. What you will take home? That’d be your equity minus the costs of selling the property. These costs might include your agent’s commissions (usually around 5–6% of your sales price), unpaid property taxes, and any closing costs not paid by the buyer.
If your home sells for $200,000 and your mortgage on the home is $150,000, your equity is $50,000—but you owe a commission of $12,000 to your realtor. Your other closing costs such as escrow fees, title charges, and tax prorations add another estimated $3,000 in seller-paid costs. Your net equity is now reduced to $35,000: $50,000 minus the additional $16,000 in expenses.
How Is Home Equity Built?
Homeowners can build home equity in two key ways: by increasing their home’s value or by reducing the amount they owe on the property. You can do this by:
- Making a larger down payment. The more you put down, the smaller your loan balance will be—meaning more home equity.
- Making your monthly mortgage payments—and then some. Every mortgage payment goes toward reducing your debt and increasing your equity. Adding in an extra payment or two a year can help, too.
- Improve your house. Upgrading your home and making smart improvements can also increase its value and therefore your equity stake. For example, you might spend $50,000 on remodeling your kitchen and this increases the market value of the home by $30,000. Now you've increased your equity by $30,000, assuming you didn't take out a home equity loan to pay for the new kitchen.
Sometimes, homes increase in value due to external factors, such as local market demand, growth in the community, etc. When this happens, this also increases a homeowner’s equity stake in their property.
To see if your home has increased in value due to outside influencers, look at comparable sales in your neighborhood. If homes in your area are now selling for more, that means your home would likely sell for more, too.
As an example, you might have bought your home two years ago for $100,000 with a 20% down payment. Similar homes are now selling for $120,000. Your equity in the home has increased by $20,000 due to this rise.
How Do You Lose Equity?
You can also see your home equity fall. A decrease in local home values is one way it can happen. This can occur due to economic conditions in the area, changes to the neighborhood, deterioration/aging of homes in your area, and more. Basically, if homes are selling for less in your area, then your equity will fall as a result.
Here are some other ways you can lose equity:
- Increasing your loan amount (or the number of loans on your home). If you refinance your mortgage or take out a second mortgage or home equity loan, you'll most likely decrease your equity, too.
- Letting your home fall into disrepair. As your home’s condition depreciates, so does its value—and the equity you have in it.
- Market changes. Overall changes in your local real estate market and economy can also impact your home’s value and your equity.
If you’re worried you may be losing the equity in your home, you might want to talk to a local real estate agent. They can pull local comparable sales to gauge your home’s fair market value and make recommendations for how you should move forward.
The Bottom Line
Equity is a powerful thing. Build more of it, and see a higher return on your investment when it comes time to sell. Allow your home to lose equity, and you might stand to lose cash once you offload your property.
The moral of the story? If you own a home, keep tabs on your equity and where you stand. Take action early if you see things heading in the wrong direction, as it could help prevent financial loss when you’re ready to sell.