Home equity can provide many homeowners with an alternative form of finance for large home improvement projects, other large expenses, and even a debt consolidation.
Home equity loans and home equity lines of credit (HELOC) are two common ways homeowners can obtain credit against their home.
Before you take out any loans, however, you should calculate how much equity you have in your home and what your LTV is.
How Much Equity do you have in your home?
Home equity is the difference between the current market value of your home and the balance of your mortgage. Lenders use equity and loan-to-value ratio calculations to determine if you qualify for a refinance, home loan, HELOC, or other home-related loan.
Understanding your home equity can also give you an idea of what to do with a sale of the home after applying a sale price to the outstanding mortgage balance. Whether you want to borrow against your home equity or want to know how much you could make selling your home, here’s how to calculate your home equity:
1. Estimate the market value of your home
To determine the equity of your home, you first need to know what it is worth. The easiest way to estimate this is to enter your address into an online home price calculator such as those offered by Zillow or Redfin. But you shouldn’t rely too much on the numbers. “These generators provide instant estimates, but they’re not the most accurate,” said Mark Reyes, CFP, financial advisory expert at Albert, an automated money management and investment app.
“That gets to the point, but be aware that this is based on algorithms [evaluating] Houses similar to yours. It’s definitely not 100% accurate, and it can be a little bloated, ”says Reyes.
A real estate agent can provide a more accurate number based on their knowledge of the market – or you can even pay for a home valuation, which is the most accurate but can cost anywhere from $ 500 to $ 2,000.
For this exercise, let’s say the current market value of your home is $ 250,000.
You can build equity in your home by paying a substantial down payment on your mortgage, by making your monthly payments on time, and by living in your home for as long as possible.
2. Find the balance of your mortgage
Once you have an idea of the real market value of your home, you should confirm your mortgage balance or how much money you still owe on the home. You can find this number in your account on the lender’s website, on your most recent credit statement, or by calling the lender directly. While you might need a formal withdrawal offer for the exact number, the pending financier can give you a good idea of where you are at.
For this example, let’s say you have a mortgage balance of $ 160,000.
3. Subtract your mortgage balance from the value of your home
Once you have the value of your home and the size of your mortgage loan, calculating your home equity is relatively simple: subtract the mortgage balance from the home value to get the equity amount in dollars.
|Home equity||Outstanding Mortgage Balance||Home Equity Estimate|
|$ 250,000||$ 160,000||$ 90,000|
Essentially, if you are valuing your home equity to understand how much money you could make selling your home, this is where you can essentially stop. The exact amount you would go with will depend on the lender’s exact withdrawal details as well as the closing costs, but this number can give you a rough idea of what you could make from selling your home, assuming it gets in that market sells value number you will receive.
4. Calculate the loan-to-value ratio
When looking to take out a home loan or HELOC, lenders consider your LTV ratio as a measure of your home equity. This calculation helps lenders estimate the likelihood that you will be able to repay the loan. You can find your LTV by dividing your mortgage balance by the value of your home:
|Mortgage balance||Home equity||LTV ratio|
|$ 160,000||$ 250,000||64%|
Lenders view higher LTV ratios (less equity) as riskier, 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 Use Your Home Equity
There are two ways you can capitalize on your equity: home equity loans and HELOCs. Both allow you to withdraw funds based on the value of your home to help consolidate debt, fund home improvement projects, pay tuition, and other important expenses.
Generally, you need a maximum of 80% LTV (or 20% equity) to receive a home equity loan or HELOC. Remember that these loans pose an additional risk than other unsecured loans such as personal loans or credit cards because your home is the security. So if you default on the loans, your home could go into foreclosure.
These two loans are most beneficial when used to get you on a better financial path or to fund a project that would add to the value of your home. But if you are still in control of your finances, that extra debt can get you into trouble.
You should make sure you have an emergency fund in place before taking out a home equity loan or HELOC, Reyes says. “For me as a financial advisor, this shows that there is a deeper problem where there is cash flow issues or your bills are beyond your income. A HELOC would be a plaster at this point. ”
A home loan is a fixed rate loan that allows you to withdraw some of your equity in the form of a one-time check. Typically, loan amounts vary between $ 10,000 and $ 25,000 and can be borrowed for a fixed term of between five and 30 years. Home loans are great for large, up-front-cost projects, such as replacing a roof.
Line of credit for home equity loans
A HELOC is a floating rate, revolving credit line that enables you to borrow cash from your home equity at any time and in any desired denomination. The repayment period is divided into two periods: the drawing period, in which you can withdraw any amount at any time up to the total credit limit and only pay interest, and a repayment period in which you have to pay back all monies that you have borrowed during the drawing period, plus interest. Because of this, HELOCs are often used for projects or expenses that arise over time.