In simplest terms, your profit on a home sale is the difference between what you paid for the home and what you receive from the buyer. Equity, on the other hand, is the difference between the value of your home and what you still owe on it. Having equity in a home does not guarantee a profit when it comes time to sell.
Having equity in your home is not necessarily an indicator of the profit you will receive if you decide to sell. Your potential profit as part of a sale is also directly affected by the current value of the home relative to the price you originally paid for it.
Calculating Your Equity
Say your home has a market value of $250,000, and you still owe $150,000 on the mortgage. If you were to sell the home for its market value, you could pay off the mortgage and keep the remaining $100,000 for yourself. You therefore have $100,000 worth of equity in your home. Your equity is affected by four main factors: the size of your down payment, the amount you've borrowed, the amount you've paid off so far and whether your home has increased or decreased in value since you bought it.
Perhaps the most important first step towards accurately calculating your equity is arranging for a home appraisal. A professional appraiser must be used in order to provide a current, up-to-date assessment of your home's value.
Selling Your Home
Even if you sell your home for $250,000 and walk away with $100,000 in cash, you haven't necessarily made a profit. Your profit depends on what you paid for the home. If you paid $200,000 for the home and then sold it for $250,000, then your profit is $50,000. If you paid $235,000, then your profit is $15,000. And if you originally paid $260,000, then you're actually selling the home at a $10,000 loss, even though you are getting cash out of the deal.
Understanding Equity in Relation to Value
Say you originally bought your home for $235,000, including a $50,000 down payment and a $185,000 mortgage. Since then, you've paid the mortgage down to $150,000, and property values have risen in your area, so your home is now worth $250,000. Your equity is $100,000. But if you sell, your profit is only $15,000 -- the increase in the value of your home.
The other $85,000 you would receive from the sale is really just your own money coming back to you -- your $50,000 down payment and $35,000 in mortgage payments.
Cashing In on a Loss
Now imagine that you had originally bought your home for $260,000, including a $75,000 down payment and the same $185,000 mortgage. As before, you've paid the mortgage down to $150,000, but property values in your area have fallen, so now your home is worth only $250,000. Again, your equity is $100,000.
But if you were to sell now, you would be losing money on the deal, even though you walk away with cash. You would have paid $110,000 toward equity -- the $75,000 down payment and $35,000 in loan payments -- but would get back $100,000.
Providing a Note of Caution
For simplicity, the foregoing examples don't include the multiple fees and charges that accompany any home sale. For example, the seller typically pays the real estate agents' commissions. Those commissions will reduce your profit -- or increase your loss -- on the deal and thus reduce the amount of cash you walk away with. "Sale price" in the examples can be taken to mean the amount you receive after all fees have been taken care of.
Cam Merritt is a writer and editor specializing in business, personal finance and home design. He has contributed to USA Today, The Des Moines Register and Better Homes and Gardens"publications. Merritt has a journalism degree from Drake University and is pursuing an MBA from the University of Iowa.