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Most homeowners have a mortgage, which means they don’t actually own their home — at least not all of it. However, when you provide a down payment at the time of purchase, make your monthly mortgage payments, or your home rises in value compared to what you owe, you acquire some value in your home that doesn’t belong to the bank. That’s your home equity.
Knowing how much equity you have in your home can provide insight into your net worth. It also lets you estimate how much profit you’d be left with if you sold your home and how much money you could access by taking out a home equity loan or a home equity line of credit (HELOC).
This guide will show you exactly how to calculate your home equity and why it’s important.
How to Calculate Your Home Equity
If you own your home free and clear, your home equity is easy to calculate. It’s equal to the total appraised value of your home. You own the entire house and the bank owns none of it. But if you have one or more mortgages or other liens against your home, your equity is equal to the current appraised value of your home minus the remaining balance on your loans.
When doing this calculation, it’s important to note the current appraised value of your home is likely different from the amount you originally paid. If property values have been rising in your area, the appraised value could actually be much higher — but if property values have fallen, the appraised value may be lower. This was common during the 2008 financial crisis when real estate values tumbled.
For example, if you owe $200,000 on your mortgage but your home’s appraised value is just $175,000, you’d actually have negative equity of $25,000.
It’s also important to realize the equity you have grows with each mortgage payment you make. It increases based on the amount of principal you pay down — the interest portion of your payment goes directly to your lender as part of the cost of borrowing, so it doesn’t actually reduce your outstanding balance.
However, it’s not enough to know how to calculate the equity in your home. You should also learn how to calculate your loan-to-value ratio.
How to Calculate Your Loan-to-Value Ratio
Your loan-to-value ratio shows the percentage of your home’s total value that you still owe. You need to know this because lenders consider your loan-to-value ratio when deciding what kinds of loans — such as mortgages, home equity loans, and home equity lines of credit — you might be eligible for.
Your loan-to-value ratio also determines the interest rate you’d pay if you borrowed against the equity in your home, as well as whether you’ll need to pay for private mortgage insurance, which protects the lender in the event you default on your loan.
To calculate your loan-to-value ratio, you’ll divide your current loan balance by the current appraised value of your home. For example, if you owe $140,000 on a $250,000 home, you’d divide $140,000 by $250,000 to get a loan-to-value ratio of .56. Loan-to-value ratios are usually expressed as a percentage, so multiply this number by 100 to get your LTV ratio of 56%.
How to Tell If You Qualify for a Home Equity Loan or HELOC
Both home equity loans and home equity lines of credit are a source of affordable financing based on your property’s assessed value. To qualify for either type of financing, you’ll need to have:
A total loan-to-value ratio that meets the lender’s criteria (usually 85% or less);A debt-to-income ratio of 43% or less;A minimum credit score of 620 or higher; and an income sufficient enough to repay the home equity loan as well as other debts you have.
Qualifications vary by lender, but the better your credit score, the higher your income, and the more equity you have in your home, the more likely it is you’ll be able to obtain a home equity loan or line of credit with favorable terms.
Read the full article here: How to Calculate Home Equity