Home Equity Is Not One Number

Two estimates dressed up as one fact

Equity is a subtraction, and the two things being subtracted are of completely different types. The mortgage balance is a fact: it exists to the cent, on a statement, and it changes on a schedule that was fixed the day you signed. The value is an opinion, produced either by a model that has never been inside your house or by a professional who spent forty minutes in it. Putting a fact and an opinion on either side of a minus sign produces something with the precision of the opinion and the appearance of the fact, and that is the whole trouble with the number.

There is a second and larger problem. Even if the value were exact, the number you get is a gross figure — the position before anyone is paid — and every use you might put equity to has its own set of deductions. Selling costs you a commission and a set of transaction charges. Borrowing costs you a loan-to-value cap, an arrangement fee and possibly a valuation. Refinancing may cost you an early repayment charge on the loan you are leaving. So the useful question is never how much equity do I have, it is how much equity survives the particular thing I want to do with it, and the answer is different for each.

Gross equity: the number everyone quotes

On our property, gross equity is $420,000 minus $280,832.93, which is $139,167.07. It is worth pausing on how it got there, because the components are unequal in ways that surprise people. The owner put in $75,000 five years ago. The loan has repaid $19,167.07 of principal in that time. The market has added $45,000. So of the $139,167 standing today, 54 percent is the original deposit, 32 percent is price growth and only 14 percent is repayment. Five years of paying a mortgage does much less to your equity than five years of a market you did not choose.

The other feature of gross equity is that it is a levered quantity, and the leverage is what makes it volatile. The property is worth $420,000 and your stake is $139,167, a ratio of 3.02 to one. Every percentage point the value moves therefore moves your equity by 3.02 percentage points. A plausible five percent valuation error — well inside the accuracy of any automated model — shifts gross equity by $21,000, which is 15.09 percent of it. That is not a market crash. That is one estimate replaced by another equally defensible estimate.

Net equity: what realising it costs

Nothing converts equity into money except a sale, and the sale has a price list. On our $420,000 property the agent's commission at 5 percent is $21,000 and other costs of sale at 1.5 percent — conveyancing, title work, discharge of the mortgage, whatever local transfer charge falls on the seller — is $6,300. Net equity is $111,867.07. The deduction of $27,300 is 6.5 percent of the property but 19.62 percent of the owner's stake, which is the same leverage multiplier working in the direction nobody enjoys: costs charged on the whole asset are borne by the fraction of it you own.

The commission line is the one that differs most between markets, and our article on what an estate agent's commission actually buys sets out the six structures in full rather than repeating them here. The short version, applied to this $420,000 property: a seller paying 5 percent inclusive of tax loses $21,000; a Spanish seller at 4 percent plus tax loses $20,328; a Portuguese seller at 5 percent plus tax loses $25,830; a German seller paying half of a 6 percent total inclusive of tax loses $14,994 and an Italian seller in the same split loses $15,372. Those are the same house and the same work, and they range from 10.77 to 18.56 percent of gross equity. Whichever market you are in, the deduction is a double-digit percentage of your stake, and it is not optional in the sense of being avoidable — it is only negotiable.

Borrowable equity: the ceiling belongs to the lender

Most people who look up their equity do not want to sell; they want to borrow against it. That is a third quantity and it is the smallest of the three, because a lender does not lend against equity at all — it lends against the property, up to a maximum share of value, and your existing mortgage is already occupying part of that allowance. At a maximum loan-to-value of 80 percent, total permitted debt on a $420,000 house is $336,000. Subtract the $280,832.93 already owed and $55,167.07 is what remains. That is 39.64 percent of gross equity: more than 60 percent of the equity you are told you have is simply not available to borrow.

The maximum share is not a universal constant and it moves the answer a great deal. Push the cap to 85 percent and borrowable equity rises to $76,167.07 — a 38 percent increase in what you can draw, from a five-point change in the rule. In Italy the 80 percent figure is the threshold defining credito fondiario, raisable to 100 percent with supplementary guarantees. In Germany the 60 percent Beleihungsgrenze in the Pfandbrief act is not a lending limit at all but the share of the mortgage lending value that may sit in a covered-bond pool, which is why German lenders will exceed it while pricing the excess differently. Whatever your market's convention, ask the lender for the specific percentage and the specific value they will apply it to, because both are theirs to choose.

Where equity actually comes from

Three engines add to equity and they run at very different speeds. Amortisation is the reliable one: on our loan, year one repays $3,353.18 of principal, year six repays $4,636.83, year eleven $6,411.89 and the final year $21,973.15. It accelerates because interest is charged on a shrinking balance, so the constant payment buys more principal every month. It is the only one of the three you can be certain of, and in the early years it is the smallest.

Appreciation is the large one and the one you do not control. In year six, at an assumed 2.5 percent, the market adds $10,500 while the loan repays $4,636.83 — so 69 percent of the year's equity growth comes from a number you cannot influence and cannot bank until you sell. Our article on why appreciation is not your return works through what is left of it after inflation, holding costs and transaction friction; the point here is only that it dominates the arithmetic while being the least dependable of the three.

Improvement is the third engine and it is the one that usually runs backwards. Spend $20,000 on a kitchen and the question is how much of that the market pays back at resale. At a 60 percent recovery the property gains $12,000 and your equity falls by $8,000, because you spent cash you already owned to buy value you only partly received. At 75 percent recovery you are down $5,000. At 90 percent — a small, cosmetic, high-return job — you are down $800. Very few improvements recover more than they cost, and the ones that come closest are usually the cheap ones: paint, a tidy entrance, a working boiler. A major structural project can recover half. That is a perfectly good reason to do it if you want to live in the result, and a poor reason to do it as an equity strategy.

Why an automated valuation is a range

An automated valuation model reads recent transactions near your address, adjusts for size, age, condition and whatever attributes its data source records, and returns a point estimate. The point is a summary of a distribution, and responsible providers publish the distribution alongside it — usually as a confidence band or a forecast standard deviation. Read the band, not the point. On our property, a five percent band spans $399,000 to $441,000, which spans gross equity from $118,167 to $160,167 and borrowable equity from $38,367 to $71,967. The borrowable figure nearly doubles across a band that most people would call agreement.

Two further cautions. First, the model is only as good as its comparables: a distinctive property, a thin market or a period of few transactions all widen the true uncertainty without necessarily widening the published band. Second, the lender will not use your model. It will commission its own valuation, and where the two disagree the lender's number is the one that sets your borrowing. Treat any equity figure you read on a screen as an opening hypothesis, and treat the day the lender's valuer walks in as the day the number becomes real.

Frequently asked questions

Which of the three figures should I put in my net worth?

Net equity, if the statement is meant to describe money you could actually have. Gross equity overstates your position by the cost of every sale you have not yet made — 19.62 percent on our figures — and borrowable equity understates it, because it measures what a lender will advance rather than what you own. A common compromise is to carry the property at gross value and carry the costs of sale as a contingent liability in a footnote, which keeps the balance sheet honest without pretending you are selling tomorrow.

Does an early repayment charge belong in net equity?

Yes, whenever the transaction you are modelling would trigger it — and on a fixed-rate loan repaid mid-term it very often does. Charges are capped or shaped by law in several markets and calculated on quite different bases: a percentage of the balance, a number of months' interest, or an amount reflecting the lender's actual loss. It can easily be a four-figure sum on our $280,832.93 balance, so ask the lender for the exact figure as of the date you plan to complete, rather than accepting a rule of thumb. If your loan is variable rate, check anyway; some carry a charge inside an initial period.

Can borrowable equity be negative while gross equity is large?

Easily, and it is a common and unpleasant surprise. Borrowable equity is the maximum loan-to-value applied to the value, minus what you already owe — so it goes negative whenever your current loan already exceeds the cap the lender would apply today. On our property that happens at any valuation below $351,041.16, because 80 percent of that is exactly the $280,832.93 outstanding. At a value of $340,000 the owner still has $59,167 of gross equity and can borrow nothing at all. A falling market removes borrowing capacity long before it removes equity.

Does paying extra into the loan build equity faster than saving the money?

It builds equity exactly one-for-one — every unit of currency of extra principal raises equity by one unit — but it converts liquid savings into an illiquid asset, and illiquidity is the whole point of this article. The money that went into the loan can only be retrieved by selling or by borrowing again, and borrowing again is capped by the loan-to-value rule. The return on the prepayment is the loan rate, which is often attractive, and our article on paying a loan off early works through both sides of that trade. The equity question is separate: prepaying moves money from a place you can reach to a place you can only reach on someone else's terms.

How often is it worth re-checking the value?

Rarely, unless a decision depends on it. The balance is known and moves predictably, so between decisions the only thing changing is an estimate whose noise is larger than most annual price moves — 3.02 points of equity for every point of value, on our leverage. Checking monthly mostly measures the model's own revisions. The moments that justify a fresh look are the ones with a transaction attached: applying to borrow, considering a sale, reaching the loan-to-value threshold that removes mortgage insurance, or a genuine local shift you can point to in transaction data rather than in headlines.