Home equity can offer homeowners an alternative form of financing for major home improvement projects, other large expenses, and even debt consolidation. And with home values up dramatically in the past two years thanks to a hot housing market, homeowners have more equity to work with.
But before you borrow against it, it’s a good idea to calculate how much equity you have in your home and what your loan-to-value (LTV) ratio is.
How Much Equity Do You Have In Your House?
Home equity is the difference between the current market value of your home and the remaining balance on your mortgage and any other home loans. Lenders will use equity and LTV ratio calculations to determine whether you qualify for a refinance, home equity loan, HELOC, or other housing-related loan.
Understanding your home equity can also give you an idea of what you stand to make from a sale of the house, after applying a sale price to the outstanding mortgage balance. Whether you’re looking to borrow against your home equity or want to know how much you could make if you sell your house, here’s how to calculate your home equity:
1. Estimate your home’s market value
To determine the equity in your home, you first need to know what it’s worth. The easiest way is to estimate this by entering your address into an online home-price estimator, such as the ones offered by Zillow or Redfin. But you shouldn’t rely on the numbers too much. “These generators offer instant estimates, but they’re not the most precise,” says Mark Reyes, CFP, financial advice expert at Albert, an automated money-management and investing app.
“That gets you in the ballpark, but be aware that this is based on algorithms [evaluating] homes that are similar to yours. It’s definitely not 100% accurate, and it may be inflated a bit,” Reyes says.
A real estate agent can provide a more accurate figure based on their knowledge of the market — or you could even pay for a home appraisal, which is the most accurate but can cost between $500 and $2,000.
For the purpose of this exercise, let’s assume your home’s current market value is $250,000.
You can build equity in your home by making a substantial down payment on your mortgage, by making your monthly payments on time, and by living in your home as long as possible.
2. Find the balance on your mortgage
Once you have an idea of the true market value of your home, you’ll want to confirm your mortgage balance, or how much money you still owe on the home. You can find this number from your account on the lender’s website, on your most recent loan statement, or by calling the lender directly. While you need a formal payoff quote for the exact number, the outstanding principal can give you a good idea of where you stand.
For this example, let’s say you have a $160,000 mortgage balance.
3. Subtract your mortgage balance from your home’s value
Once you’ve determined your home’s value and how much you own on the mortgage, calculating your home equity is relatively simple math: Subtract the mortgage balance from the home’s value to get the dollar-amount of equity.
|Home Value||Outstanding Mortgage Balance||Home Equity Estimate|
If you’re estimating your home equity to understand how much money you could make from a sale of your house, you can essentially stop here. The exact amount you’d walk away with depends on the exact lender payoff details, as well as closing costs, but this number can give you a high-level idea of what you could make from selling your home, provided it sells around that market value number you come up with.
4. Calculate loan-to-value ratio
If you’re looking to take out a home equity loan or HELOC, then lenders will be looking at your LTV ratio as a measure of your home equity. This calculation helps lenders assess the likelihood you’ll be able to repay the loan. You can find your LTV ratio by dividing your mortgage balance by your home’s value:
|Mortgage Balance||Home Value||LTV Ratio|
Lenders see higher LTV ratios (less equity) as being riskier for them, so the maximum LTV ratio to get a loan or line of credit is often around 80%. The lower the LTV ratio, the higher your equity, and the better your chances of getting a loan.
How to Tap Into Your Home Equity
There are two main ways you can tap into your equity: home equity loans and HELOCs. Both allow you to withdraw funds based on your home’s value to consolidate debt, fund home improvement projects, pay for college tuition, and cover other major expenses.
Generally, you’ll need a maximum 80% LTV ratio (or 20% equity) to get a home equity loan or HELOC. Keep in mind these loans pose additional risk than other unsecured credit like personal loans or credit cards, since your home is the collateral. If you default on the loans, your home could go into foreclosure.
These two loans are most beneficial when they’re used to put you on a better financial path or fund a project that would improve the value of your home. But if you don’t already have a firm grasp on your finances, this additional debt could get you in trouble.
You should make sure you have an emergency fund before taking out a home equity loan or HELOC, Reyes says. “To me, as a financial advisor, that’s showing there’s a deeper underlying issue where there’s cash flow issues or your bills are exceeding your income. A HELOC would be a Band-Aid at that point.”
Home equity loan
A home equity loan is a fixed-rate loan that allows you to withdraw some of your home equity in the form of a one-time check. Usually, the loan amounts vary between $10,000 and $25,000 and can be borrowed for a fixed term between five and 30 years. Home equity loans are great for big projects with an upfront cost, like replacing a roof.
Home equity line of credit
A HELOC is a variable-rate, revolving credit line that allows you to borrow cash from your home equity anytime you want, in any denomination you want. The loan term is divided into two periods: the draw period, in which you can withdraw any amount at any time up to the total loan limit and just make interest-only payments, and a repayment period, during which you’ll need to pay back all the funds you borrowed during the draw period, plus interest. Because of this, HELOCs are often used for projects or expenses incurred over time.