Learn How To Calculate Home Equity

For most homeowners, their house is their biggest financial asset. Knowing how much equity you have in your home is crucial for everything from basic financial planning to refinancing and selling decisions. But, how do you calculate your home equity?

The formula is simple: Deduct the outstanding balance on your mortgage from your home’s current value. However, understanding how to arrive at an accurate calculation of your equity and how much equity you can borrow requires a bit more explanation.

How To Calculate Your Home Equity In 3 Steps

To calculate your home equity, you need to find two key pieces of information and then plug them into a formula.

Step 1: Determine The Value Of Your Home

The first step in your home equity calculation is to determine the value of your home. You can use online estimators, such as the Rocket Mortgage® Property Report, to get an estimated market value, but an appraisal by a professional appraiser will provide greater accuracy. An appraisal may cost somewhere between $450 – $550 for a single-family home, but the exact cost will depend largely on the home’s location and size.

If you plan on refinancing your mortgage, your lender will likely require an appraisal. The cost of the appraisal can sometimes be rolled into your new loan along with other closing costs.

Step 2: Figure Out How Much You Owe

Next, you need to find out how much you owe on your mortgage loan. You can reference your latest mortgage statement, call your mortgage company or log into your online account.

Step 3: Subtract Your Loan Balance From Home Value

The final step is to plug the values from steps one and two into the correct formula. To determine your home’s equity, take the home’s appraised value and subtract the current mortgage balance. If you’re not looking to refinance and just want a ballpark estimate of your home equity, you can subtract your loan balance from the estimated market value you find online.

An Example Of Calculating Home Equity

For example, if an appraiser determines your home is worth $400,000 and you find your mortgage balance to be $200,000, you have $200,000 in equity:

$400,000 - $200,000 = $200,000

Calculate How Much Equity You Can Borrow

Your equity is your money, but you typically won’t be able to access all of it at once. Usually, lenders will let you borrow 80% to 85% of your home’s appraised value. Then, you’ll need to deduct the amount you owe your mortgage lender, if you still owe anything. The remainder will be the amount of your equity you can take out in cash.

Example Of How Much Equity You Can Borrow

Here’s an example of how much you can borrow in equity on a house with an appraised value of $400,000 and a remaining loan balance of $200,000:

• 80% of $400,000 = $320,000
• $320,000 - $200,000 = $120,000 in available equity

The Role Of Loan-To-Value Ratio

Your loan-to-value (LTV) ratio is the inverse of your equity. So, for example, if you have 40% equity in your home, your LTV will be 60%. LTV ratio, expressed as percentage, is the amount you owe on your home divided by its appraised value and then multiplied by 100.

The lower your LTV ratio, the better, but an 80% LTV ratio is a common threshold for being approved to borrow from your home’s equity. The type of loan you’re applying for and the lender you choose will determine how high your LTV can be, however.

Keep in mind, too: To calculate your LTV percentage, a lender looks at what’s known as combined loan-to-value ratio (CLTV ratio) – which factors in any amount you still owe on your mortgage plus the amount of equity you’re borrowing in dollars. So, this is the actual amount that will be divided by the appraised value.

Ways To Access Your Home Equity

Most homeowners have three ways to access home equity while staying in the home: cash-out refinance, home equity loan or HELOC.

• Cash-out refinance: This is a new mortgage that replaces your existing first mortgage with a loan that has a higher balance. You then receive the difference in cash to use however you want. Your lender will give you the funds in one lump sum, and you’ll have to pay closing costs.
• Home equity line of credit (HELOC): This is a line of credit you can typically draw on for 5 – 10 years, depending on the lender. You must pay interest on the amount withdrawn during this time, but you can repay the amount borrowed, too, just like a credit card. After the draw period, you must make principal and interest payments to repay the full amount used.
• Home equity loan: A home equity loan is similar to a HELOC in that it’s a type of second mortgage, but it differs from a HELOC in that it provides all your funds in a lump-sum payment. You’ll be responsible for making payments on the home equity loan as well as your first mortgage.

What Can You Do With Your Home Equity?

You can use your home equity in several ways. Here are some of the most popular options:

• Eliminate private mortgage insurance (PMI). If you have a conventional loan and build at least 20% equity in your home, you can request that the lender cancel your PMI, which is the mortgage insurance required for a conventional loan where the borrower has equity of less than 20%. Once you have 20% equity, your loan-to-value ratio (LTV) is 80% and you no longer need to pay PMI.
• Make home improvements. If you liquidate some of your home’s equity, you can use the funds to pay for home renovations. This is one of the best uses of home equity because you reinvest in the home, increasing its value.
• Pay for tuition. A home equity loan can be used to cover your child’s college tuition or room and board costs beyond any scholarships or financial aid they can receive.
• Consolidate debt. Credit card interest rates are generally much higher than mortgage rates. Using your home equity can help you consolidate your debts into one loan, saving money on interest and paying only one bill each month.
• Start a business. If you need capital to start your dream business, you can borrow the funds from your home equity, paying a lower interest rate than you might for a personal or business loan.
• Build an emergency fund. If you haven’t saved 3 – 6 months’ worth of expenses, a home equity line of credit (HELOC) can provide access to the funds needed in an emergency. You don’t have to spend the funds, but they’re there if you need them. Keep in mind: Some lenders, including Rocket Mortgage, don’t offer HELOCs.

The Bottom Line

It’s important to know how to calculate home equity, how much of your home equity you can use, how to access it and the best ways to use it. You can let your home equity accumulate or put it to work with a cash-out refinance, home equity loan or HELOC.

If you’re ready to embark on your journey of building home equity by purchasing a home, start the mortgage approval process today.