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If you’re wondering, “How much equity do I have in my home?”, you’re not alone in your concern. While it’s normally assumed that homeowners know what their home equity is, the reality is that most of them are clueless and worried!
In this article, you’ll get a good idea of how to calculate the equity in your home, and how to increase it over time. If you’re a homeowner, you need to understand how home equity works. This is especially important if you’re looking to refinance a mortgage or borrow money by using your residence as collateral.
If you’re applying for a home equity loan or a home equity line of credit, all lenders will want to look into your home equity and loan-to-value ratio (LTV). The higher the LTV, the lower your equity will be — making the lenders reluctant to let you borrow against it.
What is equity?
Equity is the actual amount of homeownership you have. It’s calculated by keeping in mind your house’s value and the amount you owe on your mortgage loans.
To put it simply, home equity is the difference between the appraised value of your home and your balance loan amount.
Read more: Home equity for millennials
How much equity do you have?
Once you figure out how much equity you have in your home, you can calculate how much money a lender will be willing to let you borrow.
Here’s simple math for calculating your home equity: Subtract your existing mortgage balance (with all the mortgage liens) from the current market value of your house and you will get the amount of equity you have in your home.
Let’s explore these calculations in more detail.
1. Find your home’s current market value
Since home values fluctuate according to the local housing markets, you need to get an estimate of your house price. It’s a good idea to seek the advice of a real estate agent or a home appraiser to know how much your home is worth.
2. Evaluate your mortgage balance
Calculate how much you owe on all your mortgages. Your most recent mortgage statement or online account will come handy. You could even call your lender(s) to get the loan balance.
3. Find the difference between the two values
Your home equity will be the amount you get after subtracting your mortgage balance from your home’s market value. Suppose your home’s value is $400,000 and your total mortgage amount is $180,000, the equity in your home will be $220,000 ($400,000 – $180,000)
4. Calculate your loan-to-value ratio
If you’re applying for a home equity loan, you need to figure out if you can actually borrow against your equity. Your LTV ratio will help money lenders decide whether to approve or reject your loan application.
Here’s how to calculate your LTV ratio: Divide your mortgage balance by your home’s current market value.
$180,000/$400,000 = 0.45 percent.
Higher the LTV ratio, the more risk it’s for your lender. That’s why most loan lenders set a maximum LTV ratio.
5. Estimate how much you can borrow
Apart from your LTV ratio, lenders also see your credit score and income to determine how much you can borrow against your equity.
To get a good idea of the amount available to borrow, multiply your home’s value with the maximum percent borrowed and subtract the total mortgage debt.
Using the above example, the amount available to borrow will be $140,000. $400,000 x 0.80 (maximum percent borrowed) – $180,000.
Most lenders allow you to borrow up to 75 to 90 percent of your available equity. The exact amount depends on the lender, type of loan, your credit score, and income.
Read more: Benefits of Remodeling Loans
How to tap into your home equity
Once you know your home equity and how much you can borrow, the next step is to choose the right loan type. Your loan options include:
- Home equity line of credit aka HELOC: A great option for funding multiple home improvement projects. You can borrow up to a maximum limit set by the lender during a draw period (generally of 10 years). This period is followed by a repayment period (generally of 20 years) when you can repay the remaining balance.
Like a credit card, you can borrow the amount you need, pay down the line of credit, and even borrow again. The interest rates are usually variable.
- Home equity loan aka HEL: This fixed interest rate loan allows you to borrow a lump sum of money upfront. You can repay it in equal installments of monthly payments over the loan term.
Read more: Home Renovation Loans
Whether you choose a HEL or a HELOC, you can use the funds for pretty much any purpose. This could be debt consolidation, higher education fees, any emergency expense, or major home improvement projects that could increase your home’s value.
Another advantage is that the interest in both these loan types may be tax-deductible if the money is being used for home improvements.
Do remember that since the lenders of these loans use your home as collateral, you cannot afford to fall behind on your monthly payments. It could lead to a property foreclosure!
That’s why it’s important that you make all your payments on time, and borrow only what you absolutely need.
How do you increase your equity?
Increasing your equity will help improve your finances; whether it’s getting the best financial options, a mortgage refinance or paying private mortgage insurance.
Typically, it takes four to five years for your house to increase in value — enough to make it worth selling. If you want to build your equity a little faster, you can take the following steps:
- Pay down your loan’s principal and lower your loan-to-value ratio.
- Get your payments amortized (set a schedule and repay the loan in full by the end of the loan term).
- Avoid an interest-only loan.
- Pay more than the required mortgage payment every month. Of course, only if there are no prepayment penalties. This will quickly reduce your loan balance and lower your loan to value LTV ratio.
- Protect the value of your home by keeping it well-maintained and making appropriate home improvements that increase its value.
- Home equity is the ownership stake you have in your home.
- Your equity will determine your loan and how much you are borrowing against your home.
- Most lenders will let you borrow between 75% and 90% of your available home equity.
In the end, economic conditions will affect your home’s value. With increased home prices, your LTV ratio will drop and your home equity will increase.