The Dynamics of Home Equity

Appreciation and amortization are key factors in building equity for homeowners with mortgages.  As the home goes up in value due to appreciation and the unpaid balance goes down due to amortization, the equity increases.

Appreciation is the increase in value of a home and is usually measured year over year.  In recent years, appreciation has been robust (19% nationwide in 2021) due to high demand and low inventory.  Many times, the news will quote annual appreciation rates from a national or regional level.

Occasionally, you may see a chart that tracks the annual appreciation over a period, but it is more interesting than it is practical.  It can be used to determine an average rate over a longer period that you can use to project future growth.

The reality is that supply and demand determine appreciation along with location and condition.  To reflect more accurately what your individual home has appreciated, you'll need to find local numbers which your real estate professional can provide.

The amortization of a loan is consistent with regular monthly payments based on the term of the mortgage.  Homeowners frequently receive a monthly statement, either through the mail or online, from their lender declaring the current unpaid balance.

If a homeowner makes additional principal contributions toward the loan, the unpaid balance will accelerate the normal amortization schedule.  Additional principal payments on fixed-rate mortgages shorten the term of the mortgage.  Additional principal payments on adjustable-rate mortgages will lower the payment on the next anniversary date.

Equity in a home is the difference between the value of the property and what is owed on in.  If there is no mortgage on a property, the equity and value of the home are the same.

To illustrate how equity is influenced by appreciation and amortization, let's look at an example of a $400,000 purchased today that appreciates at 3% a year using a 90% mortgage at 4% for 30 years.  The $40,000 would grow in seven years to $182,135 in equity with $91,950 coming from appreciation and $50,186 from amortization.

If the appreciation in the same hypothetical example is increased to 5% annually, the equity would be $253,026 with $162,840 coming from appreciation and the same $50,186 from amortization.  The same loan amount, rate and term will result in the same unpaid balance as the example with lower appreciation.

With the considerable appreciation experienced in recent years, the values are going up fast and benefit the people who currently own a home while making it more expensive for would-be buyers.  Another factor facing buyers is rising interest rates.

It is important to get the facts about the market and your individual situation to determine what alternatives you have to purchase a home in the near future.  Your agent can provide this objectivity and recommend a trusted mortgage professional to be pre-approved.

For more information, download our Buyers Guide.