A: Calculating equity is simple: you take the market value of your home and subtract any outstanding mortgages or liens. So if you have a $100,000 home and have $60,000 left to repay on your mortgage, your equity would equal $40,000.
The amount of equity you have is not constant, however. It changes depending on your home’s value, market conditions and the terms of your mortgage. The simplest way to increase your equity is to pay off your mortgage. The more you pay towards the principal, the more equity you will accrue. In the beginning, most of your payments will likely go toward the interest, so you will build equity much slower in the first couple of years in your new home. You can build equity faster if you shorten the term of your mortgage, as more of your payments go toward principal. Once you have paid off your mortgage, the lien on the title will be cleared and you will own 100 percent of your home.
You can also increase your home’s equity by making improvements that increase its value. Be careful here, however, as renovations rarely recoup their full cost. The best strategy is to make renovations that bring your house up to par with other houses on the block and to avoid souping up your house with upgrades and designer appliances the rest of the neighborhood doesn’t have.
Best of all, your equity may increase without you doing anything. If property values in your area increase, so will your equity, as it is based on market values. Using the above example, if property values in your area increase by eight percent, your equity would equal $48,000. But housing market conditions are affected by a number of things, including interest rates, inflation and the economy. And while houses tend to appreciate over time, it is possible for these conditions to lower property values and result in a decrease in your equity. In a worst-case scenario, this could result in negative equity, where the amount of your mortgage exceeds the value of your home.
Negative equity could also occur if you have an interest-only mortgage. In these cases, your monthly payments may be covering just the interest or only a portion of it. At the end of the interest-only term, you still owe the lender the principal as well as any unpaid interest, possibly meaning that you owe more than the market value of your home.
To help avoid negative equity, make sure at least some of your mortgage payments are paying down the principal and try to buy a home in an area where property values are increasing.
The good news is that national home values generally appreciate by an average rate of five percent per year, and home prices have on the whole increased steadily since 1968, increasing by 8.8 percent in 2004, according to the National Association of REALTORS®. This wealth is readily accessible through home equity loans, which tend to have lower interest rates and may have tax benefits.
You can also use our home equity calculator to calculate your home equity.
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