What it means
In personal finance, a home sits on the balance sheet as an asset at its estimated market value, usually offset by a mortgage (a loan secured against the property) shown as a liability. The gap between the two is called home equity, and it is the owner's true financial stake in the property.
Lenders, advisers and tax authorities all use this simple split when they look at a household's finances. Owning a home costs far more than the monthly mortgage payment.
Property taxes, insurance, repairs, maintenance and utilities all add up, and a common rule of thumb is to budget somewhere between 1% and 2% of the home's value each year for upkeep alone. Many first-time buyers underestimate this and find that the true monthly cost is well above the mortgage figure on the brochure.
Homes matter to lenders, employers and business owners because housing is the biggest line in most household budgets. Lenders judge affordability by comparing housing costs with income, and founders often borrow against home equity to fund a start-up.
That puts the family home at risk if the business fails, which is why advisers urge caution before mixing the two. Buying versus renting is a financial decision as well as a lifestyle one.
Buying ties up a deposit (the cash paid upfront) that could earn a return elsewhere, and it brings transaction costs such as legal fees and taxes on purchase. Renting avoids those costs and the burden of repairs but builds no equity, and the break-even point depends on how long the owner stays, local prices and borrowing costs.
A home is also illiquid, which means it cannot be turned into cash quickly without cost or delay. Selling takes weeks or months, agents and lawyers charge fees, and the final price is only certain once a buyer signs.
Because value can fall as well as rise, treating a home as a guaranteed investment has hurt many households when local markets weakened. Finally, a home is a concentrated bet.
A household that owns one property in one town has a large share of its wealth tied to that local market and to the same economy that pays its salary. Spreading savings across other assets is the usual way to reduce that concentration.
In practice
Real-world examples.
Example
A marketing manager buys a $360,000 apartment with a $72,000 deposit and a $288,000 mortgage. On day one her equity is $72,000, and each monthly repayment of principal (the part that reduces the loan) adds to it. After a few years of repayments and modest price growth, she can see her net worth rising without touching her salary.
Example
The founder of a small software firm takes a $100,000 second charge (a second loan secured on the same property) against his home to cover payroll for six months. If the firm recovers, he repays it and keeps the house. If it fails, the lender can claim the property, so the founder's business risk has become his family's housing risk.
Example
A retired teacher in a small town compares her home's $300,000 value with her $40,000 of savings. She sees that most of her wealth is tied up in one illiquid asset and decides to downsize to a cheaper property. The $120,000 she frees up gives her a cash cushion for retirement and lowers her running costs.
Formula
Calculation
Home equity = Market value of the home - Outstanding mortgage balance
Loan-to-value ratio = Outstanding mortgage balance / Market value of the home x 100
Suppose a home is worth $450,000 and the remaining mortgage is $270,000. Equity is $450,000 - $270,000 = $180,000, and the loan-to-value ratio is $270,000 / $450,000 = 0.60, or 60%. If local prices then fall 10%, the home is worth $450,000 x 0.90 = $405,000. Equity drops to $405,000 - $270,000 = $135,000, a fall of $45,000 or 25% of the original equity, and the loan-to-value ratio rises to $270,000 / $405,000 = 66.7%.Case study
Seen in the real world.
Marlowe Family Holdings is an illustrative, fictional household of two working parents who bought a home for $400,000 using an $80,000 deposit. For five years they paid the mortgage, covered maintenance and watched local prices rise, so they felt wealthy on paper. They rarely looked at their cash savings, which sat at a modest $15,000.
When one parent lost a job, they discovered how illiquid the home really was. Selling would take months and cost about 6% of the price in agent and legal fees, and borrowing more against it required income they no longer had. The home was worth $480,000 on paper, yet they had no quick way to reach that value.
In this illustrative story the family cut spending, rented out a spare room and rebuilt their emergency savings to cover six months of costs. The lesson is that equity is a measure of net worth, not a source of cash on demand, and that a healthy balance sheet needs liquid savings alongside the property.
Watch out
Common mistakes.
- Treating the home as a risk-free investment that will always rise in value, when local prices can stall or fall for years.
- Counting only the mortgage payment as the cost of owning, and forgetting taxes, insurance, repairs and maintenance.
- Confusing the home's market value with the owner's equity, when equity is the value minus what is still owed on the mortgage.
Questions
People also ask.
Is a home an asset or a liability?
It is an asset at its market value, but the mortgage secured on it is a liability, and the difference is the owner's equity.
Does a home count as part of net worth?
Yes, net worth includes the home's value less the mortgage, although advisers often show it separately because it is hard to spend.
Should a home be included in an investment portfolio?
Advisers usually look at it alongside the portfolio rather than inside it, because a large home already gives heavy exposure to the local property market.
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