Home equity can be a valuable resource for homeowners. It can be used to fund major home upgrades, pay off high-interest debt, make a big-ticket purchase or meet important financial goals.
Before you explore options to access equity, calculate the amount you have in your home. This figure, along with your loan-to-value (LTV) ratio, determines the likelihood of being approved for a home equity loan or home equity line of credit (HELOC) and how much funding you could be eligible for.
How much equity do you have in your home?
Equity is the difference between your home’s appraised value and the amount you owe on your mortgage (and any other loans against the home). It’s a relatively simple calculation, assuming you have accurate figures on hand.
Step 1: Estimate your home’s value
First, identify the property’s market value. You can find out how much your home is worth using a number of methods, but mortgage lenders rely on the appraised value — based on a professional appraiser’s opinion — to determine your equity level.
If you’re simply exploring options, however, an easier (and free) way to gauge your home’s worth is to use an online home price estimator. These popular online tools rely on a unique algorithm and publicly available information to generate estimates.
Keep in mind: When you input your address in an online estimator, you’ll get an estimate of the fair market value, not the appraised value. The fair market value of your home refers to what a homebuyer would pay for the property today. Again, a lender will look to the appraised value, not fair market value, when determining your home equity options.
Step 2: Find out what you owe
Once you have an idea of your home’s value, you’ll also need the outstanding balance on your mortgage (or mortgages), which can be found on your most recent statement. You could also check your lender or servicer’s online dashboard or call directly for this information.
Step 3: Take the difference
Assume your home’s current value is $300,000, and you have a $180,000 balance remaining on your mortgage. Subtract the $180,000 outstanding balance from the $300,000 value. Your calculation would look like this:
- $300,000 – $180,000 = $120,000
In this case, your equity in this example would be $120,000.
Calculating LTV and CLTV ratio
Once you know how much equity you have in your home, you can determine if it’s sensible to borrow from it. An important factor is your LTV ratio, your mortgage balance divided by your home’s value expressed as a percentage. Using the above example, you would make the following calculation:
- $180,000 / $300,000 = 0.60 (60 percent)
A higher LTV ratio indicates more risk for the lender. For a home equity product, lenders typically set a maximum combined LTV (CLTV) ratio of around 85 percent or less. The CLTV includes your first mortgage and any other loans attached to your home, including the HELOC or home equity loan you’re applying for.
Step 4: Determine how much you can borrow
Most lenders allow you to borrow up to 75 percent to 90 percent of your available equity, but each has a unique formula to determine your borrowing threshold.
If the lender allows you to borrow 80 percent, for example, you’d use this calculation:
- ($300,000 [home’s value] x 0.80 [maximum percent borrowed]) – $180,000 [amount owed] = $60,000 available to borrow
How to access your home equity
- Home equity line of credit: A HELOC is flexible and allows you to fund multiple projects over time. Once approved, you can borrow up to a set limit during the draw period, which generally lasts for up to 10 years. As with a credit card, you can borrow what you need when you need it, pay down the line of credit and borrow again. Interest rates are usually variable and could change over time. Once the draw period ends, the principal balance converts to a loan that’s repayable over a set period of up to 20 years.
- Home equity loan: A home equity loan allows you to borrow a lump sum of money upfront and repay it in equal installments with a fixed interest rate. It could be ideal if you know how much you need and prefer a predictable monthly payment and stable interest rate.
Advantages and disadvantages of borrowing equity
Whether you decide on a home equity loan or a HELOC, the funds can be used however you see fit. Many homeowners use the money for home improvement projects, which can increase their home value and help them get the best deals when they eventually sell their homes. Plus, the interest on a home equity loan or HELOC may be tax-deductible if the funds are used for home improvements.
Some borrowers also consolidate high-interest debt or pay for higher-education costs and emergency expenses.
The main drawback of a home equity loan or line of credit, however, is that your home is used as collateral to secure the loan. So if you fall behind on payments, the lender has a legal right to place a lien on your property and foreclose on the home.
Also, be mindful you could end up owing more on your mortgage than what your home is worth if your property value declines after you borrow against the equity. In this scenario, it’s much harder to get approved for a new loan with more favorable terms.
Consequently, it’s important to borrow only what you need and to make all your payments on time.
How to increase equity in your home
As you follow your repayment schedule and pay down your mortgage, you’re building equity in your home. If you make extra payments, you can boost your equity level sooner. Assuming your loan doesn’t have a prepayment penalty (most don’t, but confirm with your servicer), you might choose to pay a little more each month, or make biweekly payments or an extra payment once a year.
Another way to preserve your equity: Keep up with home maintenance. While market conditions affect the value of your home, so does its condition.