When someone talks about equity in real estate, they’re referring to the part of a property’s value that the owner actually owns, free from any debt. But how does equity work, and, more importantly, how can it benefit you? Whether you’re a homeowner, an investor, or just someone who’s curious about the property market, understanding the “equity” definition in real estate can make all the difference.
In this article, we'll define equity in real estate, offering insights into how it works, practical examples, and ways to leverage it to build wealth.
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What is equity in real estate?
Real estate equity is the portion of your property you truly own, calculated as the difference between your property's market value and any outstanding mortgages or liens. As you pay down your mortgage or as property values increase, your equity grows, becoming a valuable financial resource.
“Equity rises as more mortgage payments are made and the outstanding loan amount decreases, and it also rises when home prices increase due to market dynamics,” says Betsy Pepine, founder and CEO of Pepine Realty.
How to calculate
Equity in real estate is calculated as the difference between the property's market value and the amount still owed on any mortgages or loans secured by the property.
Your home's current market value is the price it would likely sell for today. You can find this by looking at recent sales of similar homes in your area or using online valuation tools.
Once you have this value, check your mortgage balance, which is the amount you still owe on your home loan. This information is available on your latest mortgage statement.
With these numbers in hand, it's just a quick subtraction to figure out your equity. For example, if your home is valued at $400,000 and you owe $250,000, your real estate equity is $150,000.
Equity in real estate: Examples for different scenarios
Below are a few other examples that illustrate different scenarios affecting real estate equity, highlighting how factors like market appreciation, mortgage payments, and property improvements can impact your overall ownership stake.
- Increased home value: Suppose you bought a house for $300,000 with a $60,000 down payment. If the value of your home rises to $350,000, your equity will increase to $110,000. This is calculated by adding your initial $60,000 equity to the $50,000 increase in your home's value.
- Paying down the mortgage: Imagine having a mortgage balance of $200,000 on a home worth $300,000. Over time, as you make regular mortgage payments, your loan balance decreases. If it gets down to $150,000, your equity is $150,000, reflecting the amount of the home you own outright.
- Renovation boosts: Imagine investing in a $30,000 kitchen renovation for your home, which increases its market value by $50,000. This improvement directly boosts your equity, adding $20,000 in value beyond your initial investment.
Evaluating your home's value growth
Determining whether your home has appreciated can provide valuable insights into your financial growth. “There are several ways to see if your home has increased in value,” Pepine says. “You could hire an appraisal from a licensed appraiser. You could ask a realtor to run a comparative market analysis on your home. Many will do this free of charge for you.”
For a quick estimate, you can check the house value on specific online platforms. “If you just want a ballpark idea of what your home is worth, you can type your address into a public home search engine site like Zillow or Homes.com and see what value they are currently placing on your home,” Pepine says. These platforms often feature a “claim this home” option, enabling homeowners to update details for a more accurate valuation.
Additionally, examining your property on your county’s property appraiser website can offer insights. This value is generally 10-15% below true market value but can show how your home’s value has changed over time.
Observing local real estate trends is also insightful. If homes in your neighborhood are selling for more than they did last year, it indicates potential appreciation. For example, if houses previously sold for $350,000 and are now selling for $370,000, that reflects a $20,000 increase.
Understanding home appreciation not only highlights your property's current value but also indicates increased equity. Greater equity means enhanced ownership and financial leverage, improving your financial position and potential opportunities.
What can you do with home equity?
Equity in real estate is more than just a number; it's a versatile financial tool. “The most common thing homeowners do with their home equity is to get a home loan or open a home equity line of credit (HELOC) on their home,” Pepine says.
Here’s a breakdown of these options and other ways to make the most of your home equity:
- Get a HELOC or home loan. A home equity loan or HELOC lets you borrow money using your home's equity as collateral. “These products typically have competitive rates and flexible repayment terms, saving you money by eliminating the need to take on debt at higher rates and less flexible terms,” Pepine says.
- Invest in additional properties. Leveraging your home's equity allows you to purchase additional properties, such as rental homes, which can generate a steady income stream and contribute to your long-term wealth.
- Engage in house flipping. Another approach is house flipping, which involves purchasing homes that require some work, renovating them, and selling them for a profit. This method demands market knowledge and renovation skills but can yield substantial returns.
- Enhance current property value. Enhancing your current property through renovations can directly increase its market value. For example, investing $20,000 in a kitchen remodel might boost your home's value by $30,000, resulting in a net gain of $10,000.
- Manage and reduce debt. Managing and reducing debt with home equity can also improve your financial health. Paying off high-interest debt using your equity reduces your interest obligations, freeing up funds for reinvestment or savings. This strategy can also enhance your credit score and financial stability, facilitating easier access to loans for future investments.
By focusing on sustainable growth and sound financial principles, you can transform your real estate equity into a catalyst for lasting wealth. Make informed decisions, plan strategically, and confidently navigate your path to financial prosperity.
Refinancing to build real estate equity
Refinancing involves replacing your current mortgage with a new one, often with better terms or interest rates. Here’s how it can be beneficial:
- Accessing cash: When your home's value appreciates significantly, refinancing can be a smart way to tap into some extra cash. For instance, if your home's value rises to $350,000 and you still owe $200,000, a cash-out refinance might let you secure a new mortgage for $250,000. This means you could access the additional $50,000, which can be used for major expenses or investments, offering you financial flexibility.
- Lowering interest rates: Refinancing can also help lower your interest rates, which is a major win for your wallet. Imagine if market rates fall from 6% to 4%—refinancing under these conditions can cut down your monthly payments and reduce the total interest you pay over the life of your loan. This not only saves money but also allows you to allocate funds to other financial priorities.
- Shortening loan term: This means paying off your mortgage faster, which reduces the total interest paid and builds equity more quickly. Choosing a shorter loan term through refinancing can be a wise financial move.
Now is the time to assess your own equity opportunities and consider leveraging this asset to boost your financial future. Empower yourself with this valuable knowledge and take action to make real estate equity work to your advantage.