How to Calculate Home Equity

Home equity is the financial stake you have in your home, and if you’re like most people, it’s a big portion of your total net worth. If you’re thinking about selling or contemplating accessing equity with a home equity loan or line of credit, it’s important to understand how much equity you have in your home. 

What is home equity?

Your home equity is your personal financial investment in your home. Generally speaking, it’s your home’s fair market value, less any mortgage balances or existing liens — including the balance you owe on your mortgage.

It’s important to note that your home’s equity is not the same as your net proceeds. When you go to sell your house, you’ll have to pay closing costs and other fees related to the transaction. These expenses are paid directly out of your equity before you can even access the money, thereby decreasing your total profit.

How does home equity work?

When you first purchase a home, your equity is simply your down payment amount. Then, as you pay off your mortgage balance, any payment applied toward the principal increases your equity. Your equity also increases as your home’s value rises with your local real estate market. In an ideal world, the market is healthy and appreciating, and your equity and net worth increase over time. 

There are three ways your equity increases. And no matter how you are gaining equity, more equity is always better. It’s an asset that you can tap into down the road when you decide to sell, take out a second mortgage or get a reverse mortgage. 

1. Equity increases with mortgage payments

Every time you make a mortgage payment, part of your payment goes toward principal, and part goes toward interest (you may also pay property taxes and homeowner’s insurance as part of your payment, but for brevity’s sake, let’s just consider the parts of your payment that affect your equity). The principal is what builds your equity.

At the beginning of your mortgage, the bulk of your payment will go toward interest for your lender. The change in the principal versus interest payment over time is called an amortization schedule. Depending on the length of your loan and your interest rate, at some point down the road, the balance will shift, and the majority of your payment will go toward principal, helping you build equity even faster. 

2. Equity increases with market appreciation

As long as housing market conditions are healthy, your home’s value should appreciate over time. Of course, how much equity you’ll gain (and if you risk losing equity) depends on your timing. 

For example, if you bought at the height of the market — in 2006, for instance — and then tried to sell during the Great Recession, you might have ended up with negative equity. Also called “being underwater,” negative equity is when you owe more on your home than it’s worth. Since markets typically appreciate over time, being underwater on your loan is relatively rare. 

3. Equity increases with home improvements

You can also increase your equity by completing home improvements. New mechanicals, landscaping, additions and renovations (when done strategically and with budget in mind) often boost your home’s value, in turn increasing your equity stake. 

Some of the most popular home improvements include minor kitchen remodels, exterior improvements, bathroom remodels and finishing basements. It’s rare to complete a home improvement project with a 100% return on your investment, but you can come close if you take a strategic approach. Focus on improvements that buyers love, and be cautious of over- improving. 

How to calculate home equity

Now that you know what home equity is, you probably want to know how much equity you have in your own home. Knowing roughly how much equity you have is helpful if you’re thinking of selling, and it’s also an important factor if you’re considering a home equity loan or line of credit — more on that later. 

Most people don’t own their homes outright. According to the Zillow Group Consumer Housing Trends Report 2018, 59% of homeowners are still paying a mortgage on their homes. This means that calculating equity isn’t as easy as simply assessing your home’s market value. 

1. Find out what your home is worth

Depending on when you purchased your home, it might be worth more or less than you initially paid for it. To find out what your home is worth, run the comps yourself or have your real estate agent provide a fair market value for your home, based on similar recently sold properties in your area. Here’s an example to walk you through the calculation: You purchased your home in June 2013 for $250,000 with a 20% down payment and a 4.07% interest rate. Today, your home is worth $315,000. 

2. Subtract your loan payoff amount

Now you’ll want to factor in your remaining mortgage balance. Contact your mortgage lender to get a loan payoff amount, which is also called an estimated settlement statement. 

Note that your loan payoff is not the same as the loan balance you see on your monthly payment. A loan payoff factors in interest up to your estimated closing date, whereas your statement is only calculated once a month. Your loan payoff might also include a prepayment penalty if you’re selling soon after buying. For the purposes of this exercise, we’ll assume your closing date is today. 

If you don’t have a remaining mortgage balance, your equity is equivalent to your home’s current market value. 

Example: Keeping the same example as step one above, with your 20% down payment, you originally borrowed $200,000. After six years of monthly mortgage payments, your loan balance as of June 2019 is $176,472 with your 4.07% interest rate. 

3. Take the difference as your equity

Subtract your loan balance amount from your home’s current market value. 

Example: Fair market value of $315,000 minus $176,472 in loan payoff amount equals $138,628. 

Remember, that doesn’t mean you will pocket $138,628. At closing, you’ll still need to pay closing costs, which can include taxes, escrow fees and agent commissions, all of which can total 8% to 10% of the sale price. At 10% in closing costs, you’ll end up netting $124,765. 

If you really want to get into the details of your profit, you may also want to subtract any money you spent getting your house ready to sell, like home improvements, repairs or staging.

How much equity do I need to sell my house?

To sell your house, you’ll want at least enough equity to cover closing costs, commissions and any liens on the property. Liens include any outstanding debts on your property, like if you neglected to pay a contractor or are behind on your property taxes or HOA dues. 

Without this equity, you’ll have to bring money to the closing table to settle up your debts. Remember, closing costs can reach 8% to 10% of the sale price, which includes 6% in agent commission and 2% to 4% for other charges. 

Home sale price What you’ll pay in closing costs (8% to 10%)
$175,000 $14,000-$17,500
$225,000 $18,000-$22,500
$275,000 $22,000-$27,500
$325,000 $26,000-$32,500
$375,000 $30,000-$37,500
$425,000 $34,000-$42,500
$475,000 $38,000-$47,500
$525,000 $42,000-$52,500
$575,000 $46,000-$57,500
$625,000 $50,000-$62,500

If you have negative equity and are at risk of foreclosure due to missed payments, you might consider a short sale, but it can be a challenging process. Your lender will have to agree to it, since they’ll be accepting less for the home than they’re owed. And it can have a significant negative impact on your credit score. 

What happens to equity when you sell your house?

When you sell your home, your home equity is given to you in cash, less any applicable closing costs, your mortgage balance and any other outstanding liens on the property. 

Here’s how the process works:

  1. The buyer and/or their lender transfers funds to the escrow account. 
  2. Your escrow agent pays off your mortgage, based on the loan payoff amount. They’ll also pay off any outstanding liens. 
  3. Your escrow agent pays off any transaction fees, including commissions, property and transfer taxes, or prorated HOA fees. 
  4. The remaining proceeds are transferred to the you, the seller. You are now free to use that money to purchase another home or pursue another investment. 

How long does it take to free up my equity when selling?

The average time between a home going under contract and closing is 45 days, but that doesn’t include the time it takes before you receive (and accept) an offer. In 2018, the typical U.S. home spent between 65 and 93 days on the market, from listing to closing. The time on the market varies greatly depending on local market conditions, demand and seasonality. 

Part of what makes closing on a home so time-consuming is the buyer’s loan process. Since 77% of buyers use home loans to purchase, according to the Zillow Group Report, they have certain contingencies they need to meet before they’re “clear to close,” including completing a lender-ordered appraisal and having all of the loan paperwork prepared. 

If you want to free up the equity in your home sooner than two to three months, try the following:

Find an all-cash buyer: Cash buyers can typically close faster, as they don’t have a lender to wait on. They also may waive contingencies to speed up the process. But you’ll still have to take the time to find your cash buyer first! 

What happens to equity in a reverse mortgage?

With a reverse mortgage, you slowly give up equity over time in exchange for monthly cash payments. It’s a way to access the equity in your home without selling, and it’s available to homeowners of retirement age who already have significant equity in their homes. 

How much equity do I have in my home to borrow?

If you want to tap into your equity to make home improvements or pay for other expenses, you have a few options, including a home equity loan and a home equity line of credit (HELOC). 

Here are a few common reasons homeowners might want to take out a home equity loan or HELOC:

  • Pay for college, if the interest rate is lower than student loans
  • Complete home improvements that raise the home’s value
  • Invest in other types of investments with a higher return
  • Pay off high-interest debt
  • Have an emergency fund available for medical bills or unforeseen expenses 

Traditional home equity loan

A home equity loan is a lump sum loan that you pay back in monthly installments over 5 to 15 years. It is secured by the equity in your home. Here are key features of a home equity loan:

You owe interest on the whole amount: When you apply for a home equity loan, you request a specific dollar amount, then pay interest on the entire amount you’ve borrowed. How much you borrow determines how much you’ll pay each month. 

Interest rates are fixed: Home equity loans have a fixed rate that won’t change over the life of the loan. 

Home equity line of credit (HELOC)

Like a home equity loan, a HELOC uses your home’s equity as collateral. However, it differs in a few key ways:

It is a revolving line of credit: Instead of borrowing a set amount upfront, a HELOC allows you to borrow against the equity in your home on an as-needed basis. Withdraw what you need over time, based on your financial needs. A HELOC can typically be opened up to a loan-to-value ratio of 85%. 

You only owe interest on what you borrow: Much like a credit card, you only pay interest on the amount you borrow, not the total amount you are approved for. 

Interest rates are variable: Your interest rate will vary based on the prime rate. This can be good news if rates drop but bad news if interest rates are on the rise. 

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