A home's value is the sum of the debt on the mortgage and the equity. When a house changes in value, the owner loses or gains some of the value of the equity. When a home is sold, the owner receives the balance of the equity after fees.
The equity and debt value of a property are calculated using the total debt as well as the market value of the home. For example, if the market value is $500,000 and the remaining debt is $400,000, the equity value is $100,000. Your equity value rises when you pay off debt or when the market value rises. When you sell your house, the proceeds you receive equal the equity minus any fees paid to agents and any other closing costs incurred by the seller.
Advantages of Equity
Having a large amount of equity value in your home gives you a measure of financial flexibility. When you sell your home, you will likely have a large sum to use as a down payment on your next house. You also have the ability to borrow money against your house using a Home Equity Line of Credit if you need cash. A line of credit has no limits on use and can be spent on home improvements, major purchases, investments, cars, medical bills or anything else you choose.
An appraiser or licensed real estate agent can estimate the market value of your house by analyzing recent sales of similar homes in the same area. Adjustments in the value are then made for all of the particular features of your property, such as the amount of land you own, upgrades that have been made to the home and the school district in which your house is located.
After the 2008 financial crisis and housing bubble, millions of homeowners lost value in their homes. In fact, many people lost so much value that their equity was completely wiped out, and they had more debt than the market value of the home. This situation is also referred to as "underwater" or "upside down" on your house. According to a report by CoreLogic, there were 10.8 million homes with negative equity in the U.S. in the second quarter of 2012. This equaled 22.3 percent of all home mortgages. This puts owners in a very difficult situation because if they sell the house they owe more on the mortgage than they would get for the house.
Kathy Zheng is a personal financial planner. She holds a Bachelor of Arts in economics and is certified as a level 1 financial adviser.