First, a cautionary tale:
During the pandemic, if you owned a home in a rural area, you probably could have made some serious dough from selling your house. But historically, that hasn’t always been true. In my latest book Miss Independent, I share a story from a woman who I advised:
I inherited $15,000 from my grandmother. I thought I would buy a foreclosed house for pennies on the dollar and then rent it out.The home’s market value was $100,000 but I got it for $50,000 and put $10,000 down. The monthly mortgage payments were about $500. At the time I had my cousin and her husband move into town so I was able to rent it to them for $700/month. Renting to family wasn’t as bad as it sounds. But the back end to owning a property and getting it ready to rent was a royal pain in the ass. While my cousin lived there, I needed to hire a landscaping and maintenance person, so I was probably making $100/month. After they moved out, I felt like I had tried this rental property thing and it wasn’t for me with the workload at my job so I sold it. I thought, because I got the house for basically half the price I would at least sell it for $75,000–$85,000. Wrong-o. I sold it for around $55,000. I ended up putting a little bit of money into a light renovation to sell the house and had to comply with the buyer’s, um, extensive punch list. At the end of this saga, I estimate that I broke even. I put about $12,000 into the house and got about $12,500–$13,000 out of it, accounting for all the broker’s and other fees. In hindsight, my time and energy were more valuable than the small profit. I wish I would have put that money from granny into a safe investment in the market. I believe I could have at least got the same return or maybe slightly better but I would have saved precious hours of my life.
It’s all about equity.
In order to understand whether you’ll make a profit when selling your house, you’re going to need to understand how homeownership works, and how it’s not as simple as it looks. It’s really a question of how much of the house you own—or, how much equity you have in the home. The calculation to figure out your equity is very simple.
Home Value – Mortgage = Equity
Let’s say you bought your house for $300,000. We’re also going to assume that you paid a 20% down payment. So, your equality at first would look like this:
$300,000 (Home Value) – $240,000 (Outstanding Mortgage) = $60,000 (or, your Equity).
In other words, in the beginning of your homeownership journey, you have 60 grand of equity in your house.
After three years of making payments, you’ve probably paid off another $30,000 of your mortgage (this doesn’t necessarily take interest into consideration, but let’s just call it 30k for easy math). That means after three years, you’re now looking at an equity calculation of:
$300,000 (Home Value) – $210,000 (Outstanding Mortgage after three years)= $90,000 (your Equity).
As you pay off your mortgage, you gain more and more equity in the house, until you pay off your mortgage in full. That is the moment you’ve been waiting for: you can officially call your house all yours. There are two reasons equity is important to homeowners: 1) equity affects how much you can make if you sell the house and 2) you can borrow against the equity you have in your house… but that’s a topic for another article.
Back to our earlier example. If you have $90,000 of equity in your house—great! That’s $90,000 with your name on it. But how do you get it? Houses are an illiquid asset; meaning, that $90,000 isn’t in between your floorboards. Unless you’re borrowing against your equity, the most common way to cash in on your equity is to sell your asset.
If you decide to sell this $300,000 house, you might think: sweet! $300,000 in my pocket! And start looking at treehouse listings on AirBnb for a $300,000 vacation. Alas, that’s not how it works.
Before you can pocket any profit, you need to settle the rest of your mortgage. If you sell now, the only money going into your pocket would be your equity: $90,000; you’ll need to make sure the lender receives the remaining $210,000 in mortgage payments. This is yet another reason to opt for a 15 year mortgage because you earn equity much faster.
Say you’re cool with all of this and you decide to go through with the sale… you now have to think through a new problem: your house is sold and you need to find a new place to live. You might just end up having to buy another $300,000 house… which is liiiiikely pretty similar to the one you just had. Unless you downsize, could be a wash.
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