When Does Home Equity Count in Your Net Worth?
If you’re like many people, your home is probably your biggest asset, so you might think it makes sense to include it in your net worth. But this may not always be the best idea.
Here’s why: All your assets usually should be tallied as part of your net worth. But some financial advisers argue that the money you’ve invested in your home is different from other assets. If most people were to sell their home and move, they would have to put the funds from the sale toward buying or renting a new home. The home you live in isn’t easily liquidated if you need money to pay for other things.
The specifics of your situation can also determine whether or not to count your home equity in your net worth. And there is no downside to calculating it both ways. Generally, when using tools to tap your home equity, you may want to include your house as part of your net worth. But when calculating retirement savings and in some other situations, it’s a no-go.
Read on to learn more about when home equity counts in your net worth.
Table of Contents
Key Points
• Home equity is the difference between the market value of your home and the amount you owe on your mortgage.
• Building home equity can increase your net worth and provide financial stability.
• Home equity can be accessed through a home equity loan or a home equity line of credit (HELOC).
• Using home equity wisely, such as for home improvements or debt consolidation, can be a smart financial move.
• It’s important to carefully consider the risks and benefits of using home equity and consult with a financial advisor.
Why Is Knowing Net Worth Important?
Your net worth will fluctuate over time, but it can always be a valuable way to chart how your finances are going. If your net worth is negative, that means you have more debts than assets. This might encourage you to budget differently or focus more on paying off debt, especially high-interest debt.
If, however, your net worth is positive, that can help you see how you are progressing toward financial goals and what funds you will have available for, say, retirement.
Calculating Net Worth
At its most basic, net worth is everything you own minus everything you owe.
To calculate your net worth, tally the value of all or your assets, including bank accounts, investments, and perhaps the value of your home or vacation home. Then subtract all of your debts, including any mortgage, student loans, car loans, and credit card balances.
If the resulting figure is negative, it means that your debts outweigh your assets. If positive, the opposite is true.
There is no one net worth figure that everyone should be aiming for. Your net worth, though, can be a personal benchmark against which you can measure your financial progress.
For example, if your net worth continues to move into negative territory, you know that it is time to tackle debts. Hopefully, you’ll see your net worth grow, which can give you some idea that your savings plan is working or your assets are increasing in value.
Your home may, strangely, function as both an asset and a liability. Your home equity — the part of the home you actually own — can be an asset. But your lender may still own part of your home. In that case, mortgage debt is a liability.
As you track your home value and other assets to take your financial pulse, you may find that your home is simultaneously your biggest asset and biggest liability.
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When to Include Home Equity in Net Worth
Generally speaking, you may want to include your home as part of your total assets and net worth when you want to leverage the value of the equity you have stored there.
You can tap the equity in your home with a number of financial products. Here’s a closer look:
Home Equity Loan
A home equity loan allows you to borrow money that is secured by your home. You may be able to borrow up to 85% of the equity you have built up. For example, if you have $100,000 in home equity, you may have access to an $85,000 loan.
The actual amount you are offered will also be based on factors such as income, credit score (which may differ among the credit bureaus — say, between TransUnion vs. Equifax), and the home’s market value.
You repay the lump-sum loan with fixed monthly payments over a fixed term.
As with home improvement loans, which are personal loans not secured by the property, you can use a home equity loan to pay for home renovations.
Or you can use a home equity loan for goals unrelated to your house, like paying for a child’s college education or consolidating higher-interest debt.
Just remember that if you fail to repay the loan, the lender can foreclose on your home to recoup its money.
Home Equity Line of Credit
A home equity line of credit (HELOC) is not a loan but rather a revolving line of credit. You may be able to open a credit line for up to 85% of your home equity.
How do HELOCs work? You can borrow as much as you need from your HELOC at any time. Accounts will often have checks or credit cards you can use to take out money. You make payments based on the amount you actually borrow, and you cannot exceed your credit limit. HELOCs typically have a variable interest rate, although some lenders may allow you to convert a portion of the balance to a fixed rate.
HELOCs use your home as collateral. If you make late payments or fail to pay at all, your lender may seize your home.
Traditional Refinance
A traditional mortgage refinance replaces your old mortgage with a new loan. People typically choose this path to lower their interest rate or monthly payments.
They may also want to pay off their mortgage faster by changing their 30-year mortgage to a 15-year mortgage, for example, reducing the amount of interest they pay over the life of the loan.
How do net worth and home equity come into play? One important metric lenders use when deciding whether you qualify for a mortgage refinance is your loan-to-value ratio (LTV), how much you owe on your current mortgage divided by the value of your home.
The more equity you have built in your home, the lower your LTV, which can help you secure a refinanced loan and positively influence the rate of the loan.
Another option: A cash-out refinance vs. a HELOC.
Cash-Out Refinance
A cash-out refinance replaces your mortgage with a new loan for more than the amount of money you still owe on your house.
The difference between what you owe and the new loan amount is given to you in cash, which you can use to pursue a number of financial needs, such as paying off debt or making home renovations.
Your cash-out amount will typically be limited to 80% to 90% of your home equity, and interest rates are typically a little bit higher due to the higher loan amount.
Reverse Mortgage
A home equity conversion mortgage, the most common kind of reverse mortgage, allows homeowners 62 and older to take out a loan secured by their home.
Borrowers do not make monthly payments. Interest and fees are added to the loan each month, and the loan is repaid when the homeowner no longer lives there, usually when the homeowner sells the house or dies, at which point the loan must be paid off by the person’s estate.
When You Should Not Count Home Equity as Part of Your Net Worth
There are a few instances when it doesn’t make sense to include your home in your net worth, or you aren’t allowed to.
When Calculating Your Retirement Savings
If you’re using your net worth to get a sense of your retirement savings, it may not make sense to include your home, especially if you plan to live there when you retire.
Your retirement savings represent potential income you will draw on to cover your living expenses. Your home does not produce a stream of income on its own, unless you tap your equity using one of the methods above.
If You’re Applying for Student Aid
A family’s net worth can have an impact on eligibility for federal student aid. The more assets a family has, the more that need-based aid may be reduced.
However, the equity in a family’s primary residence is a nonreportable asset on the Free Application for Federal Student Aid (FAFSA®). Most colleges use only the FAFSA to decide aid.
Several hundred colleges, usually selective private ones, use a form called the CSS Profile, which does ask applicants to report home equity, though a number of schools, such as Stanford, USC, and MIT, have moved to exclude home equity from their considerations for aid.
When Becoming an Accredited Investor
An accredited investor may participate in certain securities offerings that the average investor may not, such as private equity or hedge funds. Accredited investors are seen to be financially sophisticated enough, or wealthy enough, to shoulder the risk involved with such investments.
To become an accredited investor, you must have earned more than $200,000 (or $300,000 together with a spouse or spousal equivalent) in each of the prior two years, or you have a net worth over $1 million. However, you cannot include the value of your primary residence in your net worth in most cases. (An exception worth noting: There are certain FINRA licenses that allow a person to become an accredited investor independently of one’s finances.)
Tips for Improving Net Worth
If you are looking to build your net worth, you might try these tips:
• Rein in your spending. If your net worth is not rising as you would like, you might assess if you are spending too much. You might be shopping out of boredom, trying to keep up with your peers (aka, FOMO or Fear of Missing Out), or be experiencing what is known as lifestyle creep, when your expenses rise along with your income.
• Deal with your debt. Having debt, especially high-interest debt like the kind you can incur with credit cards, can make it hard to grow your net worth. If you are struggling to get on top of debt, you might look into debt consolidation options or working with a low-cost or free credit counselor.
• Consider automating your savings. Many financial experts advise that you “pay yourself first” and immediately transfer some funds into savings when you get paid. In one popular budgeting method, the 50/30/20 Rule, it’s recommended that 20% of your take-home pay go toward savings and debt. In addition, you would probably want that money to grow, whether that means putting it in a high-yield savings account or investing in the market.
The Takeaway
Whether or not you include your home in your net worth will depend largely on what you’re trying to accomplish. If you plan to tap your equity, then it is an important figure to include. But it’s not always included when it comes to things like student aid or retirement income.
Having a handle on your home equity and keeping it growing is always worth the effort and hard work. The more it grows, the more it can contribute to your long-term financial goals.
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