Home equity is the difference between a home’s fair market value and any outstanding loans on the property. When homeowners have a mortgage, they do not actually own the whole home — the mortgage lender has an interest in it as well. As the mortgage is paid down over time, the homeowner’s equity grows and the lender’s interest decreases until the house belongs entirely to the buyer.
How to Calculate Home Equity
For example, if a home’s current fair market value is $600,000 and the homeowners have a mortgage balance of $400,000, their equity in the home is $200,000.
As you can see, the equation to calculate home equity is quite simple:
The hard part, however, is determining your home’s current market value. If you’ve lived in your home for at least a few years, this is unlikely to be the same as the price you paid for it originally.
How to Determine the Market Value of a Home
If a home’s market value goes up — due to improvements made to the home or general strength in the housing market — the homeowner’s equity goes up as well. If the market value goes down — due to damage or destruction of the home or a poor housing market — the homeowner’s equity goes down with it. As such, it is important for homeowners to take great care in ensuring that they do whatever they can to maintain or increase their home’s market value over time.
Knowing a home’s current market value is critical but — short of selling — how can homeowners find out what this number really is? There are basically three ways:
- Do a comparative market analysis. This is an informal estimate of a home’s market value. By plugging specific data into a home value calculator, available on many real estate websites, a homeowner can obtain a ballpark figure of what their home is worth. This option is good for those homeowners doing preliminary research in anticipation of selling their home in the near future, or perhaps gauging whether it is a good time to sell at all.
- Ask a local real estate agent for help. Real estate agents can look at comparable properties currently on the market or recently sold to come up with an informed estimate of a home’s potential sale price. This will only provide a ballpark estimate, similar to a comparative market analysis.
- Hire a certified appraiser. Utilizing an appraiser can cost a few hundred dollars, but it provides the most precise and accurate estimate on your home’s current market value. A professional evaluation by a certified appraiser takes many variables into consideration, including:
- Size: Square footage and number of bedrooms and bathrooms in the home.
- Interior: Construction quality, home design and floor plan.
- Location: Neighborhood, access to transportation, nearby shopping centers and schools.
- Exterior and physical features: Lot size, topography, view and quality of landscaping.
Building Home Equity
Building home equity can be very important, especially if homeowners want to use that equity to finance other financial goals. There are two main paths to speeding up equity growth: reducing the mortgage debt or increasing the home’s value. The fastest way is to do both, of course.
To Reduce Mortgage Debt...
Make a big down payment. This is instant equity in the home, so the more homeowners can put down on their home upfront, the bigger head start they get. Down payments over 20% eliminate the need for private mortgage insurance, too.
Keep up with the monthly payments. This is something that has to be done, but simply paying the mortgage builds equity, month by month by reducing the mortgage lender’s stake in the home.
Pay more than the required amount. Homebuyers can add money to their regular payments or make extra payments. Extra payments can be sent at regular intervals or just whenever extra money, like birthday gifts or work bonuses, comes in. The more frequently homeowners can make extra payments, the faster their equity will grow.
Start with or refinance to a fifteen-year mortgage. Monthly payments are higher with a shorter-term loan, but equity builds much faster. Also, as a bonus, shorter-term loans have lower rates. For those homeowners who are currently in a longer-term mortgage loan, refinancing could be a smart decision to increase monthly payments and build equity.
To Increase Home Value...
Renovate the interior. Making interior improvements and updates can help raise overall property value. However, note that not all renovations do so, and homeowners who are considering renovations should do their research. Cost-effective changes can be minor — paint, new appliances, new lighting — or major — bath or kitchen remodeling.
Add space. Although this isn’t a project to be undertaken lightly, adding space and/or additional rooms to a house can raise its value as well as accommodate a homeowner’s changing needs. Utilizing a home equity line of credit can help homeowners afford home improvement projects without imposing undue financial burden.
Pay attention to the outside. Curb appeal is important to the value of a home, so adding landscaping, installing shutters and painting the exterior are potential equity-boosters. Turning a dull back yard into an outdoor room or poolside oasis may also boost home value in the right neighborhood.
Just wait...patiently. Home prices may rise and fall in the short term but, historically, values trend upward over time. This is called appreciation.
What is Appreciation?
Appreciation refers to how the fair market value of a home increases with time. For example, a home that sold for $200,000 a few years ago may someday sell for $250,000 because prices in its neighborhood have increased.
While home values tend to appreciate over time, they do not have to. When values depreciate, equity decreases. If they depreciate enough, homeowners can end up with negative equity — a situation in which the value of their home is less than the amount they owe on their loans.
However, though housing values have risen and fallen in past decades, the general overall direction has been upward. The US House Price Index indicates that average house prices have increased by 3.4% a year since 1991, and experts see this trend continuing, at least in the near future. This figure can be useful in helping predict how your home will appreciate over time.
Local real estate appreciation rates do differ from the national rate, and whether a specific neighborhood will appreciate over time is mostly out of a homebuyer’s control.
Factors that can raise the value of homes in a neighborhood:
- New schools
- Local job growth
- Increased housing demand
- Influx of investors
Factors that can decrease the value of homes in a neighborhood:
- Destructive weather events
- Increase in crime
- School closures
- Local job loss
- Increased housing supply
- Foreclosures and vacant homes
- Rise in property tax rates
Even if you take account of these factors, predicting appreciation isn’t an exact science. You can calculate a ballpark figure, at best. It’s much easier to gauge appreciation after it has happened, and the HELOC experts at Bethpage can help you determine how much your home has appreciated since you purchased it.
Maximize Home Equity with Bethpage Federal Credit Union
At Bethpage Federal Credit Union, we offer affordable home equity lines of credit (HELOCs) to help you make the most of the value you own in your property. Apply for a HELOC today with Bethpage to get the benefits of our competitive rates, freedom from closing fees, and expert advice and guidance.