Given the high value of a home, it isn't surprising that a large percentage of many people's total financial value is tied up in their homes. What percentage of your total assets should be represented by your primary residence is an ongoing discussion among financial analysts and economists. Too low a percentage might indicate an excessively large mortgage, while too high a percentage might show a lack of other investments.
An individual's net worth is determined by adding together real estate, investments, personal possessions and other assets, then subtracting mortgages, debts and other liabilities. Total net worth encompasses liquid assets such as bank accounts as well as non-liquid assets such as a primary residence. A person who owes more than his total assets are worth has a negative net worth. People who live in areas with high real estate values tend to have a higher percentage of their total net worth represented by their primary residences.
Equity is the part of your residence that you own free and clear. If you live in a $300,000 house, but you have an outstanding mortgage of $250,000, your home equity is only $50,000. The more of your mortgage you have paid off, the more equity you have in your home, and the higher percentage of your total net value it is likely to represent. If your home represents between 25 and 50 percent of your net worth, this is considered a healthy range.
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Use Value and Market Value
The question of the market value and equity of a home represents only its market or dollar value. Its use value is not represented in the economy, because use value refers to the practical purpose of a possession. In the case of a house, its use value is that it shelters and houses you and your family. This means houses have a high value above and beyond their market value, because without them people would be homeless. The economic implication of a home's high use value is that it isn't available for immediate use as a liquid asset, because it is being used.
Leverage vs. Solvency
The higher percentage you still owe on your house, the more leverage you have. This means you are in possession of liquid assets that would otherwise be tied up in the house. To a certain point, this can be financially advantageous, but beyond a certain point it becomes risky and counterproductive. On the other end of the equation, the smaller your mortgage, the closer to solvency you are. Having no mortgage means you are entirely solvent, as least as far as real estate is concerned. This is a financially secure position, although it ties up money in your home that would be available to you for other uses if you still owed money for the house.
- The Big Picture; Home Equity as a Percentage of Household Net Worth; Barry Ritholtz; November 2010
- University of Pennsylvania; The Wharton School; Net Worth and Housing Equity in Retirement; Todd Sinai; August 2007
- The Simple Dollar; Calculating Net Worth; What Should One Do With Their Primary Residence?
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