How Equity Affects Profit for Selling Houses

Equity and profit have two different meanings in real estate.

Equity and profit have two different meanings in real estate.

One of the major benefits of owning a home rather than renting is that you can gain equity. When you first buy a house, you might hold very little equity. However, by the time you are ready to sell and move on, you've likely gained some equity, if you've made mortgage payments for a number of years. Equity doesn't directly affect the profit you'll make on the sale of your home, but it factors into the amount of money you'll be able to walk away with.

Equity

Simply put, the equity value of your home is the difference between what it's worth and what you owe on the mortgage loan. As you pay down the mortgage balance, the equity amount increases. Other factors that increase your equity are market appreciation and making improvements that increase the house's value. Equity can be illustrated with basic arithmetic. Let's say you bought your home 10 years ago for $200,000, you paid a 10 percent down payment and took out a loan for the remaining $180,000. You started out with $20,000 in equity. Over time, you updated your kitchen and master bathroom. With the updates plus general appreciation, the property is worth $230,000. If you now have an unpaid mortgage balance of $130,000, this leaves you with $100,000 in equity.

Selling Your Home

When you decide to put your home on the market for sale, determining the asking price is one of the first steps. It's important to price your home fairly. If you ask too much, you could lose potential buyers right from the start. However, if you don't ask enough then you lose out on potential additional profits on the sale. Often homeowners choose to hire a real estate agent to list their property for sale. The agent helps to determine the right price based on the physical attributes of the home and also recent sales of comparable homes in the same area. Real estate agents work off of commission, generally paid out of the seller's earnings.

Profit

Unless you're home mortgage loan is "underwater" -- meaning, you owe more on the loan than the property is worth -- you should, in theory, make some type of profit on the sale. The profit you make is the difference between what you paid for the home and what it sales for, minus any real estate agent commissions you're responsible for. Additionally, you'll need to factor in any significant expenses for improvements against your potential profit. There are also other miscellaneous fees and expenses associated with the sale, like recording and title search fees. The profit made on the sale of real estate also may be subject to the federal capital gains tax.

The Bottom Line

Having a high equity value on your property doesn't necessarily mean you'll get a higher profit. However, when the transaction is complete the equity value is your cash take-away. Using the example above, if the property sold for $230,000 the basic profit would equal $30,000, minus commission, fees and the remodeling costs. Let's say that was equal to $15,000 so the final profit ends up being $15,000. Out of the sales price of $230,000 you still owe the mortgage lender $130,000. After paying off the loan, you're still left with $85,000 in your pocket (after commission, fees and the remodeling costs of $15,000), but only $15,000 of that is considered profit.

 

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