How to Calculate Home Equity & Down Payments

Instructor: Tara Schofield

Tara has a PhD in Marketing & Management

Home equity and down payments are two aspects of getting funding for your clients' new home. By understanding these terms, you can help your clients use their funds and maximize their money for their new home.

What is Home Equity?

Your new clients are interested in buying a new home and are considering how much they can afford to pay. One resource they can consider is their home equity, the difference between what they owe on their home and the amount their home is worth. In other words, how much money they will have left after they sell their home and pay off their mortgage.

Home Equity Calculation

Home Equity = Market Value - Mortgage Value

Let's say your clients currently owe $125,000 on their home and believe their home is worth about $200,000.

Home Equity = $200,000 - $125,000

Their estimated home equity is $75,000. If they sold their home for $200,000 and paid off their debt of $125,000, they would have about $75,000 left (not considering closing costs, fees, or real estate commissions).

Understanding Down Payments

A down payment is the amount of cash a buyer has to put toward the purchase of a home. This money may come from savings, gifts from family/parents, or home equity (we will talk about that in a second). The down payment lowers the amount of money your clients will need to borrow to buy their home. The higher the down payment, the lower the mortgage will be. While there are some loans that do not require a down payment, most mortgages do require up to 20% to purchase a home, and buyers may need more than that to be able to purchase a home that is above the amount a lender will lend.

Down Payment Calculation

For instance, if your clients are looking at a $500,000 home, but are only approved for a $400,000 mortgage, they will need to make a $100,000 down payment from their own cash to be able to purchase the home.

Another way to look at down payment is the amount required to purchase the home. In this instance, the down payment is the sales price times the necessary percentage required by the lender.

Let's imagine your clients find a $400,000 home and are approved for $400,000 loan; however, the lender requires a 20% down payment. Even though they are approved for the entire purchase price, their lender will only give them 80% of the sales price. Your client must have $80,000 in cash to put toward the purchase of the house in order for the lender to give them a loan for the remaining amount.

Why do they need a down payment when the purchase price is the same as the loan approval amount? The lender wants the buyer to be financially invested in the home, which lowers the lender's risk that the buyer will not make mortgage payments. If the buyer has put 20% in for the home, there's a much lower chance that they will default on the loan.

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