If you are a homeowner, it is important to understand home equity, how it works, and how you can calculate it. Home equity is the difference between the appraised value of your home and the amount you still owe on your mortgage.
If you are looking to refinance your mortgage or want to borrow money against your home, it is even more important to learn about your equity.
How Much Home Equity Do You Have?
You can figure out how much equity do you have by subtracting the total amount of debt you owe on your home from its appraised value. For example, if the current appraised value of your home is $400,000 and you owe $160,000 on the mortgage of your home, your home equity will be $240,000.
Current Appraised Value – Current Loan Balance = Home Equity
$400,000 – $160,000 = $240,000
However, if the current appraised value of the home is lower than what you owe to your mortgage lender, you won’t have any equity in your home.
How to Increase Your Home Equity?
If your house’s market value has decreased over the time, your home equity may have decreased too. But, if it remained stable, you can build your equity by paying down your loan’s principal and lowering your loan-to-value (LTV) ratio.
If your payments are amortized, meaning they are based on a schedule by which you would repay your loan in full by the end of its terms, you can increase your equity by simply making your monthly payments.
If you wish to increase your equity more quickly, you can do so by paying more monthly payments each month than your required payments. This will help you lower your loan balance. But make sure to check that you do not have any prepayment penalties on your loan.
You can also sustain the market value of your home by keeping it well-maintained and tidy. You may also be able to increase its market value by investing in some home improvement projects or DIY home décor.
Know that the house prices have reached their record high in the U.S. lately, which offers a great advantage to homeowners who want to tap their home equity. The larger the house prices in the market, larger the appraised value, and hence higher equity to tap in to.
How Large a Home Equity Loan You Can Get?
Typically, lenders allow you to borrow up to 75%-80% of your home equity amount. Some lenders may even allow up to 90% of your equity depending on your credit score and income.
Let’s take an example, say you have $100,000 equity in your home, it means that you can take a home equity line of credit (HELOC) anywhere between $75,000 to $90,000 depending on your lender and your financial situation.
Know that, Real Estate is one of the most illiquid assets, which means there is usually a cost associated with tapping into your equity. So, if you take out a equity loan, you will probably have to pay some loan origination fees, transaction costs, and in some cases closing costs as well.
The Loan-to-Value (LTV) Ratio
Another way to demonstrate home equity is through the loan-to-value (LTV) ratio. LTV is calculated by dividing the current loan balance with the current appraised value, and then multiplying the answer with 100, to get a ratio.
For example, if your current loan balance is $120,000 and the current appraised value is $400,000, your LTV will be 30%. By using the following formula.
|Current Loan Balance ÷ Current Appraised Value = Answer * 100 = LTV value
$120,000 ÷ $400,000 = 0.3 *100 = 30%
Lower your LTV ratio is, the greater are your chances to get approved for a home equity loan or a second mortgage. A high LTV ratio indicates lower leverage which means the lender is more likely to trust you with his money.
Home Equity and LTV are both subjected to fluctuations when the market value of a home changes. Although the current economic crisis has resulted in a huge surge in house prices, the long-term effect of it is still unknown.
But now that you know how to calculate your Equity and your Loan-to-Value ratio. And how you can impact them. We hope that you are able to make more informed decisions to reach your financial goals.
And, if you are looking to tap into your home equity, right now might be a good time.
Contact us at (605) 718-9820 or schedule a call. We will let our mortgage experts help you with your home loan.