Home equity loans and home equity lines of credit allow you to borrow money using your home to secure the loan. Because lenders set borrowing amounts based partly on the amount of equity you have, it’s important to know how to calculate your home equity. Here’s how you can crunch the numbers yourself.
How much equity do you have?
Equity is the difference between your home’s appraised value and the amount you owe on your mortgage. You can figure out how much equity you have in your home by first checking your home’s current market value and mortgage balance. From there, you can calculate how much a lender could be willing to let you borrow.
1. Estimate your home’s current market value
Home values fluctuate with changes in local housing markets, so the equity in your home may have increased or decreased since you purchased it. While there are many ways to check your home’s value, the easiest is by using an online home price estimator. Zillow’s Zestimate and Redfin’s Estimate are two popular online tools. They each use an algorithm and publicly available information to generate home estimates.
These estimates aren’t foolproof, though, so it may be worthwhile to seek advice from a real estate agent or an appraiser.
In this example, let’s say your home’s current market value is $300,000.
2. Find your mortgage balance
Next, find out how much you owe on your mortgage. You can check your most recent mortgage statement or online account or call the lender to get the loan balance.
Let’s say you have $180,000 remaining on your mortgage.
3. Subtract your mortgage balance from your home’s value
Once you have data on your home’s value and your current debt, you can calculate how much equity you have in your home. To find that number, subtract your mortgage balance from the home’s market value. In this example, your calculation would look like this:
$300,000 – $180,000 = $120,000
4. Calculate your loan-to-value ratio
Now that you know how much equity you have in your home, you can figure out whether or not you can borrow from it. One important aspect of this is your loan-to-value (LTV) ratio. The LTV ratio helps lenders measure risk before deciding whether to approve or reject a loan application. To find your LTV ratio, take your mortgage balance and divide it by your home’s current market value. In this example, you would make the following calculation:
$180,000 / $300,000 = 0.60 or 60 percent LTV
A higher LTV ratio indicates more risk for the lender, so they’ll usually set a maximum LTV ratio of around 85 percent or less. In this example, the LTV falls well within that range.
5. Determine how much you can borrow
Although every lender will have a different formula for how much you can borrow — oftentimes based on your credit score and income — most lenders allow you to borrow up to 75 percent to 90 percent of your available equity. Using the above example, you would make this calculation if your lender allows you to borrow 80 percent:
$300,000 (home’s value) x 0.80 (maximum percent borrowed) – $180,000 (amount owed) = $60,000 available to borrow
How to tap into your home equity
Once you know how to calculate home equity and how much you can borrow, you’ll need to choose between loan types. These options include:
- Home equity line of credit: A good option if you need the flexibility to fund multiple projects over time. Once approved, you can borrow up to a maximum limit — which is $96,000 in the above example — during the “draw period.” These typically last for up to 10 years. As with a credit card, you can borrow what you need, pay down the line of credit and borrow again. Interest rates are usually variable, so they may change over time. Once the draw period ends, you enter a repayment period of typically up to 20 years in which you repay any remaining balance.
- Home equity loan: Allows you to borrow a lump sum of money upfront and repay it in equal installments with a fixed interest rate. This could be a good option if you know how much you need and prefer a predictable monthly payment and stable interest rate.
Whether you decide on a home equity loan or a HELOC, the funds can be used for pretty much any purpose, including debt consolidation, higher education costs and emergency expenses. Many homeowners use the money for home improvement projects, which can increase their home’s value and help them get the best deal when they eventually sell the home. Plus, the interest on a home equity loan or HELOC may be tax-deductible if the funds are used for home improvements.
The main drawback to 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.
The other thing to keep in mind is that if the value of your home declines after you’ve borrowed against your home equity, you could end up owing more on your mortgage than what your home is worth. In this scenario, it’s much harder to get approved for a new loan with more favorable terms.
That’s why it’s important to borrow only what you need and make all your payments on time. When that’s possible, a home equity loan or line of credit can be a powerful resource when you need to borrow money.