Home equity represents the portion of your home that you own based on your down payment and the mortgage payments you’ve already made. In other words, home equity is the difference between your home’s appraised value and the mortgage balance that you still owe to your lender.
Once you have enough equity in your home, lenders and banks will allow you to borrow against it to get access to financing, which can be used to pay for upgrades or repairs, consolidate debt or cover a major expense. But before taking on debt against your home, you’ll have to calculate how much equity you have.
Key takeaways
- Home equity is the difference between the amount you still owe on your mortgage and the current value of your home.
- Calculating your home’s equity is the first step to borrowing money through a home equity loan or a home equity line of credit.
- When you tap into your home equity for financing, you risk losing your property if you can’t make payments.
What is home equity?
Home equity is the market value of your home minus your outstanding mortgage loan balance. When you tap into the equity in your home, it can be an effective tool to build wealth.
You can start with a good chunk of equity when you buy your home by making a large down payment. Then, the longer you’re in your home and the more monthly mortgage payments you make over time, your equity will increase. Your equity can also go up if property values increase or if you make improvements to increase your home’s value.
Calculating home equity
A bit of math is involved in figuring this out, but it’s fairly simple. Here’s how to calculate your home equity in four steps.
1. Get an appraised value of your home
If you want to get a rough calculation of your home equity, you can look up your home’s market value by contacting a county assessor who sets an amount annually for property tax purposes. There are also online calculators that use an algorithm to determine your home’s current market value based on the prices in your area.
When you need to formally determine how much equity you have in order to get a loan or a refinance, most lenders require you to get an on-site appraisal conducted by a licensed appraiser.
2. Determine your home loan balance
Your monthly mortgage statement will show your current loan balance. Take note of how much you still owe your lender on your mortgage.
3. Calculate your home’s equity
Here’s where the math comes in. Use this equation:
Appraised home value – current home loan balance = your home equity
For example, if your home is valued at $500,000, and you owe $300,000 on your mortgage, you have $200,000 in home equity.
4. Calculate your home equity percentage
Next, determine what percentage of your home you’ve already paid off. Divide your home equity amount ($200,000 from the example above) by your home’s value ($500,000). Take the result (0.4) and multiply it by 100. Your home equity is 40%.
Can I borrow money with my home equity?
Many homeowners are cashing in on their home equity, leveraging the ownership stake in their property for types of financing that are more affordable than using a credit card or a personal loan.
If you’re going to tap the value of your home and go into debt, make sure the money will improve your financial position over the long term. Also, always pay attention to the risks when your home is used as collateral to secure a loan. Falling behind in payments means you could lose your property.
Home equity loan
A home equity loan, also considered a second mortgage, gives you access to a set amount of funds at a fixed interest rate, with your home as collateral. You can use the loan for any reason, such as paying off high-interest credit card debt. The amount you qualify for depends on the amount of equity you’ve built in your home. A home equity loan comes with a predictable monthly repayment schedule, and if you use it for certain home improvement projects, you could be eligible for a tax deduction.
HELOC
Like a home equity loan, a home equity line of credit, or HELOC, also uses your home as collateral. Unlike a home equity loan, however, a HELOC gives you access to a revolving credit line at a variable (not a fixed) interest rate. A HELOC allows you to withdraw as much money as you need during the draw period, usually 10 years, where you make payments only on interest. When the draw period ends, the repayment period starts: That’s when you’re responsible for paying back the principal balance (the original amount you took out) along with the remaining interest you owe.
Cash-out refinance
A cash-out refinance is when you replace your primary mortgage with a new mortgage loan that’s for a bigger amount. The new loan includes the balance you owe on your current mortgage as well as the equity you’ve already built, which you can withdraw as cash. That lump sum of money can be used for anything, such as paying down high-interest credit card debt or making renovations to your home.
How much can I borrow with my home equity?
Once you know how much home equity you have, you can figure out how to borrow against it. Lenders use a loan-to-value ratio, or LTV, to determine your eligibility for a home equity loan or a home equity line of credit. Here’s how to calculate your LTV:
Current mortgage balance / current home value = your loan-to-value ratio
Lenders typically allow you to borrow up to 80% of your home’s value.
How to build equity in your home
There are several ways to increase your home equity:
- Make a larger down payment.
- Decrease your mortgage balance by making extra payments over the course of a year.
- Increase the value of your home with a renovation project or enhance its exterior or interior.
- Get a new appraisal to see if your home’s value has gone up.
Pros and cons of using home equity
Pros
You can secure a lower interest rate to finance home renovations or big-ticket expenses.
You might be able to deduct the interest on the loan on your taxes if your funds were used to substantially improve your home.
You can use the money for anything you want, though it’s best to use the funds to improve your financial situation.
Cons
Since your home is used as collateral, there’s a risk of losing your property if you miss payments or default on the loan.
If the value of your home decreases, you may not be able to borrow much against it.
Some home equity loans have lengthy terms, so you’ll be paying quite a bit of interest over time.
The bottom line
Calculating your home equity can give you a ballpark idea of how much equity you have so you can tap into it for financing a project or paying for a major expense. Leveraging your home equity can be a great resource, especially when interest rates are lower than personal loans or credit cards or when home values are rising. Always remember, however, that you’ll be taking on more debt and risking your home in the process.