If you own a home, you can borrow against its value. This is one way to raise money without actually selling your house to consolidate debt, finance repairs, or pay for an expensive purchase. Before you can touch your equityhowever, you need to know how much you have.
“Most Americans’ largest asset is their primary residence,” said Peter Shea, senior advisor for U.S. consumer wealth management at Citi. “So it’s important to understand what equity is and how leverage can be used.”
How much equity do you have in your home?
There’s a bit of math involved in finding this, but it’s pretty simple. Here’s how to calculate your equity in four steps.
1. Estimate the value of your home
Although mortgage lenders usually require an appraisal of value provided by a professional appraiser or public appraiser, you can get an approximate figure from your county assessor. They will have a number on file for estate tax purposes.
There are also online pricing systems, such as Zillow and Redfin, that use an algorithm to determine market value: an estimate of what a buyer would pay for your home under market conditions in your area.
2. Determine what you owe on your mortgage
Your monthly mortgage statement will show your balance: how much you still owe your lender on your mortgage.
3. Calculate your equity
That’s where math comes in. Use this equation:
- Current Home Value – Mortgage Balance = Your Equity
For example, if your home is appraised at $500,000 and you owe $300,000 on your mortgage, you have $200,000 in equity.
How to Calculate Loan to Value (LTV)
Once you know how much equity you have, you can figure out how to borrow against it. Lenders use a loan-to-value ratio, or LTV, to determine whether you qualify for a housing loan or a home equity line of credit, or HELOCs. Here’s how to calculate LTV:
- Current mortgage balance / current home value = Your loan-to-value ratio
Lenders usually allow you to borrow up to 80% of the value of your home. If your home is worth $500,000, then you may be able to borrow up to $400,000 less any mortgages or debt carried on the property, according to Shea. “Loan-to-value requirements vary from lender to lender and are also based on your credit,” he said.
Pros and cons of using home equity
There are several major advantages to taking out a home equity loan instead of taking out a personal loan or racking up credit card debt. You can take advantage of the rising value of your property, secure a relatively low interest rate, and use cheaper debt to finance home renovations or major expenses. There’s also a compelling bonus: Home equity loan or HELOC interest payments are tax-deductible.
The main disadvantage is that you are required to use your home as collateral, which can be a risky move. If the value of your home goes down, you may not be able to borrow as much against it. And some home loans have long terms, which can mean paying more interest over time.
How to increase the equity in your home
There are several ways to increase your equity before borrowing against it. You can reduce your mortgage balance by making extra payments over the course of a year. You can try to increase the value of your home with renovations or by improving its exterior or interior. You can also increase your equity by making a larger down payment using the proceeds from the sale of a previous home. A higher revaluation can also increase your capital.
