How to calculate equity in your home

KIM PORTER
BANKRATE.COM

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.

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.

In order to calculate how much equity you have, you must first identify the property’s market value. One of the easiest ways to do this is by using an online home price estimator such as Zillow’s Zestimate or Redfin’s Estimate. Both are popular online tools that rely on an algorithm and publicly available information to generate an estimate.

In this example, let’s say your home’s current market value is \$300,000.

You’ll need the outstanding balance on your mortgage. Mortgage balance information is available on your most recent mortgage statement. You can also check your mortgage account online for the outstanding balance or call your lender directly.

Let’s say you have \$180,000 remaining on your mortgage.

Now, to calculate how much equity you have in your home, subtract the \$180,000 outstanding balance from the \$300,000 market value. Your calculation would look like this:

\$300,000 – \$180,000 = \$120,000

Your home equity in this example would be \$120,000.

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 factor 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.

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. The options include:

Home equity line of credit: A HELOC is a good option if you need the flexibility to fund multiple projects over time. Once approved, you can borrow up to a set limit 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, during which time you repay any remaining balance.

Home equity loan: A home equity loan allows you to borrow a lump sum of money up front 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 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.

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.

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.

Next steps

Calculating home equity is a simple process once you have the information needed to perform the calculations.

If you find that the equity is not as much as you’d hoped, consider taking steps to build equity, including paying down the principal on your mortgage more quickly by making extra payments each month or whenever you’re able to do so. Also keep in mind that local markets change over time, which can work in your favor. When home prices in your neighborhood tick up, the value of your home increases, which in turn increases your equity.