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How Much of Your Home do You Really “Own”?

By Graham McCaulley and Andrew Zumwalt, Personal Financial Planning Extension, University of Missouri. Adapted from MU Extension’s Home Works Program.

If you were to sell your home today, how much of the sale price would go into your pocket? If you are thinking of buying a home and then selling it in a few years, do you have an idea of how much money you will make (or lose)? Being able to answer these questions involves being able to figure out your home equity.

What is home equity?

The cash value of your home is the difference between the amount you can sell it for and the balance of your mortgage. This is referred to as your equity.

How can I increase my home equity?

When you bought your home, your only equity was your down payment. Over the years, your equity increases in three ways:

  1. Loan repayment – Part of your monthly mortgage payments increase your equity. Each year, you receive a statement from your mortgage lender telling how much of your loan has been repaid. For the first several years of ownership, most of your payment goes for interest.
  2. Improvements – If you add a garage, remodel the kitchen, or make other improvements, this can increase the value of your home, and thereby add to your equity. This increase is not based on what you paid for the work, but on how much more someone would pay for the house because the work was done. For example, adding a garage might cost $5000. But, having the garage might only increase the price you could get for the house by $3,500. A real estate agent may be willing to do a competitive market analysis of your home to determine the current market value including improvements.
  3. Appreciation – The value of your house can also increase as demand for houses increase and with inflation. This type of increase is referred to as appreciation. Appreciation rates are different, depending on the neighborhood. They also change from year to year. Your annual property tax bill will contain an assessed value. The amount of increase in this figure from year to year gives you an idea of appreciation. The appreciation your house has experienced will also be included in the “competitive market analysis” referred to in the previous paragraph.

Let’s look at what this means through an example.

Example:  $160,000 home

Say you purchase a home for $160,000 plus closing costs (which were paid in addition to the down payment and do not increase your equity in the home). You make a 10% down payment from your own funds (plus closing costs), and your mortgage is for 30 years, at 5%. Assuming your purchase price was in line with what the home is worth, your equity on day one of home ownership is $16,000 (i.e., your down payment).

After buying the home you may wish to do some home improvement projects, such as adding a garage, which in this example cost you $8,000 and increased the value of the home by $4,000. House prices in your neighborhood have been going up about 2% a year. The chart below shows what your equity will be five years after purchasing the house.

Example of home equity after 5 years – $160,000 home
Cash down payment $16,000
Principal repayment $ 11,766
Appreciation (2% per year x 5) $16,652
Improvements – Garage + $  4,000
Equity $48,418

The equity – $48,418– is how much of your home you will own. In five years, you will own over 25% of their home, which will then have a market value of $180,652.

If after five years, you decide to sell then, you would receive a little over $48,000. However, you would likely have to pay a commission to a real estate agent of about 6%. If the real estate commission was 6%, then you would likely get a check for $37,580.

Using home equity

Your home equity is an asset, and for many Americans it can be the most significant contributor to their net worth. As you build up your home equity you can use it for later in life- you may be able to sell your home and use the gain from your equity to go towards purchasing another home, financing retirement, or investing in a business or your children’s education. This assumes, though, that your home has been appreciating in value, you have been paying your mortgage, and you do not already have your equity committed elsewhere.

Some people who are still in the process of buying their home may use their equity for products such as second mortgage or borrowing through home equity lines of credit. Lenders will base a home equity loan on your equity amount (e.g., as computed in the example above). For example, a lender may estimate you could borrow 60 to 80% of the cash value of your home. There has also been increased publicity for reverse mortgages, which involves older home owners who have a substantial amount of equity in their home (or own in completely) borrowing against the value of their home, which is often presented as a way to finance retirement (see our Financial Tip on these products at https://ofsmizzou.org/reverse-mortgages/).

It can be useful to have access to this cash, but your home serves as the collateral. If you are unable to repay these loans, you will lose your home. However, if you are able to make sound decisions (such as purchasing a home you can afford to make payments on, using home equity credit wisely, and researching the value any remodeling or additions may add to your home’s value) and live in a market where your home value gradually appreciates over time, you will be able to build up your equity and increase your net worth.

NOTE: This will be the final Financial Tip until Fall semester. Have a great summer!

This Financial Tip was adapted from University of Missouri Extension’s Home Works Program, which was developed by the Department of Architectural Studies. For more information on Home Works visit http://extension.missouri.edu/edninfo/homeworks/. To find out how to attend a Home Works workshop in Missouri, contact your local MU Extension Center (local Extension contacts may be found at http://extension.missouri.edu/directory/Places.aspx).