How to calculate your home equity, and why it matters
Homeownership is often touted as one of the best ways to build long-term wealth. But your home doesn’t start to become a valuable asset the day you pay off your mortgage. As you make payments on your mortgage, you begin to build equity that can be used to help you accomplish some of your other major financial goals.
How home equity works
Home equity is the fair market value of your home, minus your existing mortgage balance and any existing liens. Building home equity begins with your initial down payment and continues to grow over time as you make more payments toward your mortgage.
It’s normal for your home equity to fluctuate over time as your home’s market value goes up and down. It’s even possible to have negative equity on your home if the amount of your home loan exceeds the dollar amount your home is worth on the market.
You could see changes in your home equity if:
There are changes in property market values in your community: A decrease in the property values of homes in your area could lower your home’s overall value and lead to lower or negative equity.
Your home’s condition improves or worsens: Your home’s condition plays a role in how its market value is determined. A well-maintained, updated home will likely be appraised at a higher value than a home that is showing signs of aging or poor maintenance.
“Home equity matters because it can give you some financial security in retirement,” says Alex Shekhtman, CEO and founder of LBC Mortgage. “It can also be used as collateral for a loan or line of credit. And, if you have a large amount of equity built up in your home, you may be able to sell it and use the proceeds to buy a smaller, more affordable home later in life.”
3 steps to calculate your home equity
To calculate your home equity, you’ll first need to determine your home’s market value and figure out how much you still owe on your mortgage. Once you’ve reached those two totals, the difference will tell you how much equity you have in your home.
Determine your home’s market value
Your home’s market value is the price someone might pay to purchase your home if you were to list it for sale. The location, size, condition, and school district, as well as the broader community and current market conditions all play a role in determining what your home is worth. There are a few ways to calculate your home's value:
Use an appraiser: When preparing to sell their homes, many homeowners will hire an appraiser to assess the market value of their home and use it as a basis to set a fair price. The appraiser will conduct a thorough review of your home and consider its condition, neighborhood, and comparable homes in the area to determine your home’s value. According to HomeAdvisor, the typical home appraisal cost ranges between $313 and $421, although that cost could rise into the thousands depending on your home’s size, location, condition, and even the time of year.
Use an online home valuation tool: Many banks that provide home lending services, as well as real-estate marketplaces like Zillow and Redfin all offer online home valuation tools to help you calculate your home’s market value. These tools may use publicly available information about your home or they’ll ask you to submit information related to your home’s size, age, location, sales history, and more to give you a fair market value.
Research comparable homes in your area: While this may not be the most accurate approach, researching homes in your area of similar size, age, and condition is another way you can get a rough estimate of your home’s market value.
Figure out what you owe on your home
The amount you owe on your home is known as your mortgage’s principal balance. That’s how much you owe on your home, minus any interest. You should be able to access this information by checking your monthly mortgage statement or contacting your lender for your most recent balance information.
Take the difference
Take your home’s market value and subtract your mortgage balance from that estimate to determine how much equity you have. Say your current outstanding mortgage balance is $200,000 and your home’s current market value is $450,000; that means that you have about $250,000 of equity in your home. Remember: this will change. Make it a goal to periodically run these numbers as you pay down your mortgage and market conditions change to have a more accurate idea of how much equity you have.
The takeaway
As you continue to chip away at your mortgage balance, it’s important to keep tabs on how much equity you have and how your home’s conditions and the broader market are impacting that figure. Knowing how much equity you have can be invaluable if you ever find yourself in need of financing in the form of a HELOC or home-equity loan, or you hope to sell your home down the line.
This story was originally featured on Fortune.com
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