A simple lesson in equity

First, let’s define equity. Equity is the difference between how much your home is worth and how much you owe on the home. Let’s look at an example:

Let’s say your home is worth $200,000 today. You put 5% down when you purchased the home 5 years ago for $185,000. You would owe approximately $163,500 today. That means you have equity of $36,500.

$200,000 (value today)
-163,500 (amount you owe today, 30-year loan)
————-
$ 36,500 EQUITY
– 9,250 (down payment)
————-
$ 27,250 CASH OUT (gross)

Remember when I said a few days ago that homeowner’s have, on average, 46 times the net worth of a renter? This is case-in-point.

Let’s say you rented a condo 5 years ago instead of purchasing the home in the above scenario. Let’s even say that you were able to find something comfortable for $950 per month, less than the $1,050 per month the above mortgage paymet would have been. Over 5 years time, you have spent $57,000 on rent; you would have spent $63,000 in mortgage payments. However, for the extra $6,000 in monthly payments, you have a net gain of $27,250. That $27,250 is part of your net worth. The addition to your net worth as a renter? Nada, nothing, ZERO.

Now, I hear you saying that there are expenses a homeowner has that a renter does not have. You are absolutely right! However, they don’t total $27,000 every 5 years ($5,400/year). As a homeowner you’ll have:

• property taxes: this varies greatly depending on where you live. in Asheville, the taxes would be approx $1,700/year
• homeowner’s insurance/risk policy: this will cost you a bit more than renter’s insurance, obviously. Lets say it’s an additional $300 a year
• home maintenance: this can vary greatly depending on the age and condition of the home. However, unless making renovations or major repairs, it should not be more than $1,500 a year (that is even high for a newer home).

So, the increased expenses for the year for the homeowner is about $3,500 per year. That is $17,500 for the 5 year period we are considering. That’s still a profit of $9,750.

But here’s where it starts to look really good … Let’s look at the same home purchase scenario as above but let’s assess it after 10 years of ownership. We’ll give it a 3% annual appreciation (low for most years but will average out between highs and lows). So, the house you paid $185,000 for originally is now worth $232,000 after 10 years (that’s a really conservative estimate but I’m feeling pretty conservative due to the current state of our market and our economy). After 10 years of mortgage payments, you now owe $147,000 on your original loan. That’s equity of $85,000!

$232,000 (value today)
-147,000 (amount you owe today)
————-
$ 85,000 EQUITY
– 9,250 (down payment)
————-
$ 75,750 CASH OUT (gross)

We are not considering all the monthly mortgage payments because you are paying a monthly payment regardless of whether you rent or own. The monthly payments are buildng that wonderful equity in your home. When renting, you are buying your landlord’s equity!

Seems to me it’s a no-brainer to purchase your home if you are financially capable of doing so. What do you think?

Now I realize that my examples don’t hold true for all markets. If you look at a 5-year period ending in a down-turned market as we are experiencing today, the numbers don’t look so good for many people across the U.S. But I must point out that my calculations in this article hold true for my market, my area of expertise, Asheville, NC. A purchase at $185,000 in many Asheville neighborhoods in 2004 would have easily been worth $225,000 in 2007 when the market was still high here, but now worth less at $200,000.

I do understand that there are markets, such a CA and FL, hit much harder than ours and my “Lesson in Equity” illustrations would be difficult to understand/accept right now for those folks.

We must all remember that the market is cyclical, values will rise again as they have done historically. Owning real estate is a great way to build wealth and now is a great time to buy because values are down. Eventually, real estate will experience appreciation again