If you want economic stability and security, you should definitely get all your financial affairs in order. And while doing that, you’ll often come across the concept of home equity and net worth. But what are they and what are the differences between them?
The main difference between home equity and net worth lies in their usability. The first one sizes up your net value in real estate while the latter refers to your accessible stock. Sometimes, they are considered synonymous with each other, which is just simply wrong.
On the other hand, many people prioritize the value of home equity over net worth. That’s not a great thing to do either. So, let’s find what they are and what makes them so different from each other.
What Is Home Equity?
Home equity is basically what’s leftover after you subtract the due mortgage amount from your real estate value. Take an $800,000 house for example. This is the current real estate value of your house on the market.
Now, if you haven’t paid off the full amount for your house yet, you should have some due mortgages. Imagine that you owe $500,000 in mortgages. You need to subtract this mortgage value from the real estate value to calculate your current home equity.
That means, for this given example, you have $300,000 as home equity. And over time, the differences in your home equity and real estate value will start to diminish. That is if you continue to pay off your mortgages.
Having a large amount in home equity can come quite handy at times. For instance – if the real estate value of your residence takes a big hike, you can actually make a profit. Again, it’s great for building financial credit and high-interest debt consolidation as well.
What Is Net Worth?
Net worth is your financial worth in its entirety. All your properties, yearly income, valuable assets, etc. are taken into account to prepare your net worth. It’s a solid statement or report of your financial situation that helps you to re-evaluate your economic stability.
Practically anything that has any (no matter how less it is) value in the market, goes into your net worth. And yes, your home equity is a part of your net worth as well.
In fact, for some people, it’s the largest share of their overall net worth. But is that a good thing or a bad thing?
Key Differences Between Home Equity & Net Worth
It’s easy to confuse home equity as net worth as the equity often constitutes a majority of the worth. But, no. Here are the key differences between home equity and net worth to help you through the misconceptions.
Overall Value
It’s super important to keep the overall value of your net worth way above your home equity. The reason comes back to the same point – accessible net worth.
If the value of your home equity is higher than your net worth, it means that you’re in debt. And that too, deep in debt. Because you also have the mortgages for the house to pay in full.
So, want to find out whether you’re in an economically sound enough position or not? Calculate your net worth and compare it against your equity. If it is high, you’re good.
Accessibility
When you’re investing in a down payment for your very own home, you’re solidifying some of your assets. Sure, you’ll save a lot in rent (a GREAT thing in the current economy), but you’ll also lose usability.
And until you sell your house or make other arrangements, you’ll not get back your money. Net worth, on the other hand, is composed of all sorts of assets and not just the frozen ones. So, while investing in something, the items from your net worth will grant you accessibility, while the equity will not.
Convertibility
Convertibility is another primary difference between home equity and net worth. You have already read about how home equity loses its accessibility. So, can you figure out why convertibility doesn’t apply to equity either?
Exactly. Because it’s somewhat of a frozen asset. I mean, it’s still super valuable but you can’t exactly do anything to it or with it until you liquidate it. You can’t just abruptly convert a house to a bunch of stocks, can you now?
What’s Accessible Net Worth?
Accessible net worth refers to the amount of wealth that you can use at any given time. Like, cash, jewelry, offline investment, and other liquid assets.
In times of emergency, you can instantly make use of this wealth if you want to use them. That’s why these types of assets are the most valuable ones. The others might have a higher market value, but these get you out of a tricky situation.
Ways to Turn Home Equity into Accessible Net Worth
Needless to say, thinking of home equity as a status quo of hefty wealthiness is a sign of extreme stupidity. So, here are a few most logical ways to turn your home equity into accessible net worth.
Sell The House
You’ll indeed get back the full amount in sizable and accessible net worth if you sell the house. You can even make a profit of some sort if you manage to sell it above the buying price!
However, it’s not that ideal of an option. Why? Because, well, you already spent so much time investing and finally buying a house of your own. How can it feel good to just let go of all that effort in one go?
Again, unless something truly untoward happens, the price of a house continues to go up. So, it’s more than likely that the owner after you will sell the house at an even better price. You could have had that extra profit if you weren’t so hasty to liquidate the amount.
Rent The House
Now, this is a pretty great road to go down. At least for me anyway. Rent the house to someone at a good price and live somewhere it’s more ergonomic. That way, you can directly use the house as a source of income.
Of course, you’ll still have to pay your rent unless you own a second home. But even then, with enough time you can get back the full amount in rent. And after that, whatever you get is pure and unadulterated profit for you.
Downsizing
Finally, downsizing is also an option if you’re that desperate and in need of accessible cash. But personally, I would advise against it as it’s never wise to make financial decisions in a desperate mind-set.
Downsizing mainly refers to settling down for something lesser than the original one. In real estate terms, it means to sell a high-profile house to buy a less expensive house.
The pros to downsizing are that you will still have ownership of a house. However, it’s pretty hard to calculate the overall costs of downsizing if you keep doing it constantly.
You may feel like you’re saving up, but in reality, you’re just moving on from one mortgage to the other. Furthermore, if you’re not cautious, downsizing can cause you to go into debt.
Conclusion
By now I’m sure you have a clearer idea of the differences between home equity and net worth. Some might put one over the other. But when selling your house knowing both is very important. Focus on building up your overall net worth while keeping equity to the bare minimum instead. After all, it’s better to use a watch that’s cheap than to use an expensive one that doesn’t even work.
