It is generally assumed that most people know what their home equity is. However, many people are still confused about the topic. As a homeowner, you need to understand how home equity works. That is especially true if you are looking to refinance a mortgage or borrow money against your residence.
Key Takeaways
- Home equity is the value of your ownership stake in your home, calculated by subtracting your outstanding mortgage from the property's market value.
- Lenders may also express your position as a loan-to-value (LTV) which represents the proportion of your home's value that is debt.
- Few lenders will let you borrow against the full amount of your home equity.
- Under normal economic circ*mstances, you might be able to borrow between 80% and 90% of your available equity.
- During the 2020 economic crisis, lenders restricted access to home equity and raised credit score requirements, especially for home equity lines of credit (HELOCs).
How Much Home Equity Do You Have?
Your home equity value is the difference between the current market value of your home and the total sum of debts (mainly, your primary mortgage) registered against it.
The credit available to you as a borrower through a home equity loan depends on how much equity you have. Suppose that your home is worth $250,000 and you owe $150,000 on your mortgage. Simply subtract your remaining mortgage from the home's value, and you'll come up with $100,000 in home equity.
How Should You Appraise Your Home?
There are a few ways to appraise your property if you're looking for a home equity loan and need to estimate the worth of your home for the loan. The most straightforward way is to hire an independent third-party; a professional appraiser may provide an accurate and unbiased assessment of the value of your home. This, however, can be a more expensive option.
There are also numerous internet programs that can estimate the value of your house based on data such as previous home sales in your region and local real estate trends. While these estimates may not be as precise as a professional appraisal, they can be a good place to start. Note that some forms of these loose estimates may not be accepted by a lender issuing a home equity loan.
Last, instead of regional real estate data, you can estimate your value by tracing down specific recent house sales in your region. In some cases where regional data is not a suitable comparison, specific sale information can provide you with an indication of what comparable homes are selling for. Keep in mind that your home may have unique qualities that affect its value (both for the good and the bad).
Be mindful that no matter which method you prefer, your lender may have loan requirements that dictate the method in which your property is appraised when you pursue a home equity loan.
How Big a Home Equity Loan Can You Get?
Very few lenders will let you borrow against the full amount of your home equity. They generally allow you to borrow a maximum of 80% to 90% of available equity, depending on your lender, credit, and income. So, if you have $100,000 in home equity, as in the example above, you could get a home equity line of credit (HELOC) of $80,000 to $90,000. Race, national origin, and other non-financial considerations should never play a role in determining how much home equity you can borrow.
Mortgage lending discrimination is illegal. If you think you've been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report to the Consumer Financial Protection Bureau or the U.S. Department of Housing and Urban Development (HUD).
Here's a second example that takes into account a few more factors. Suppose you are five years into a 30-year mortgage on your home. Furthermore, a recent appraisal or assessment placed the market value of your house at $250,000. You also still have $195,000 left on the original $200,000 loan. Remember, almost all of your early home mortgage payments go toward paying down interest.
If there are no other obligations tied to the house, you have $55,000 in home equity. That equals the $250,000 current market value minus the $195,000 in debt. You can also divide home equity by the market value to determine your home equity percentage. In this case, the home equity percentage is 22% ($55,000 ÷ $250,000 = .22).
Now, let's suppose that you had also taken out a $40,000 home equity loan in addition to your mortgage. The total indebtedness on the property is $235,000 instead of $195,000. That changes your total equity to just $15,000, dropping your home equity percentage to 6%.
How Should You Account for Transaction Fees?
Real estate is one of the most illiquid assets, so there is usually a cost associated with tapping into your home equity. If you actually sell the house, total closing costs are typically between 2% and 5% in the United States. Buyers usually pay many of these charges, but be aware that they could use these fees as an excuse to negotiate a lower sale price.
If you take out a home equity loan, you will probably have to pay some type of loan origination fee. Interest rates are also generally higher for second mortgages and home equity lines of credit (HELOCs) than for the original mortgage. After including these transaction costs, the amount of home equity you can really use is lower than the amount you have in theory.
What Is a Loan-to-Value Ratio?
Another way to express equity in your home is through the loan-to-value ratio (LTV ratio). It is calculated by dividing the remaining loan balance by the current market value. Using the second example described above, your LTV is 78%. (Yes, it's the flip side of your home equity percentage of 22%.) With your $40,000 home equity loan thrown in, it climbs to 94%.
Potential lenders use the LTV to determine whether or not to approve your applications for additional loans.
Lenders don't like a high LTV because it suggests you could have too much leverage and might be unable to pay back your loans. During times of economic upheaval, they can tighten their lending standards. That happened during the 2020 economic crisis. Especially for home equity lines of credit (HELOCs), banks raised their credit score requirements from the 600s to the 700s. They also lowered the dollar amounts and the percentage of home equity that they were willing to lend.
Both LTV and home equity values are subject to fluctuations when the market value of a home changes. Millions of dollars in supposed home equity were wiped out during the subprime mortgage meltdown of 2007–2008. Prices don't always go up. The long-term impact of 2020 on home equity remains uncertain. Indeed, home prices saw global price increases through 2021 due to the stay-at-home policy and people looking for bigger homes to fit their work, schooling, and life. Also, the growing work-from-home policies adopted by companies that might extend beyond COVID have incentivized many families to move to the suburbs from the city. All in all we are at a historic junction for the pandemic and its impact on homes and the future of it is yet to be seen.
How Is Home Equity Calculated?
Home equity is calculated by subtracting how much you owe on all loans secured by your house from your home's appraised value. It is the residual value of your home after all liabilities related to the home have been deducted.
Do I Need to Put 20% Equity as a Down Payment?
Many lenders and situations do not require a down payment of 20%. In order for a borrower to avoid private mortgage insurance, they must often have at least 20% equity in their home. However, this is not a requirement at acquisition as some lenders may approve loans with down payments with 5% down or less.
Is It a Good Idea to Take Equity Out of Your Home?
For some, it may be a good idea to take equity out of your own. A home equity line of credit allows a borrower to take capital from what they have already paid down on their mortgage. These funds can often be borrower at a lower rate of interest compared to other types of debt. In addition, a borrower may be in a more comfortable financial position having had minimized their mortgage by paying it down.
When Can I Get a HELOC After Buying a Home?
Many lenders offer a HELOC to borrowers within two months of the purchase of their home. There are number of conditions a borrower must meet in order to secure a HELOC such as a specific amount of equity in the home, a strong credit history, and other lender requirements.
The Bottom Line
To calculate your home equity, you'll need to determine the current market value of your home. This can be obtained by getting a professional appraisal or using an online home value estimator. Then, subtract how much you owe on your mortgage; this residual value is your equity position.
