How to calculate home equity for a HELOC
Understand your home equity
- Home equity is the market value of your home minus any debts against it.
- Common ways to tap home equity are through HELOCs and home-equity loans.
- To calculate your available home equity, first determine your home’s market value.
- Your property’s loan-to-value ratio can also assess how much equity you have built.
One benefit of homeownership is that you are gaining equity in your home each month. Unlike a car or a boat, which decreases in value quickly, home values typically rise over time in a thriving housing market.
When you are paying off your mortgage, the portion of your mortgage payment that doesn’t go into servicing the interest becomes like a bank deposit. It is money that can be pulled out at a future date, and used to cover major expenses or do renovations to your home.
The total of your home value and what you have paid against your loan amount represents your home’s equity. In other words, your equity is the market value of the home minus any debts against it. For example, if the market value of your home is $200,000 and your mortgage has an outstanding balance of $150,000, your home’s equity will total $50,000.
Note that these rules hold true only in a “normal” housing market. During the last housing crisis, home prices plunged across the country. Many people lost all the equity in their homes, including those who continued to pay their mortgages on time. Since the housing recovery, however, millions of Americans have regained equity as home prices rebounded.
As your home equity level rise, so will the amount of money that you can borrow against that equity.
Ways to tap into home equity
One of the most common ways of tapping equity is through a home equity line of credit (HELOC). With HELOCs, a lender will extend a maximum line of credit based on available equity in the home. The borrower can draw down and pay off that equity several times for an initial period, after which no more draws are allowed, and the borrowed amount must be paid down along with interest.
Lenders also consider home-equity levels carefully when evaluating a borrower for a home equity loan, also called a second mortgage cash-out. Unlike HELOCs, a home equity loan is paid out in full one time and the borrower immediately begins paying down the balance with interest.
How to calculate home value
It is fairly easy to get a rough idea of the amount of equity available in your home. First, however, you have to determine the value of the home itself.
Typically, when you apply for a HELOC or second mortgage, a lender will order an appraisal to determine the property’s value. Before you take that step, you can usually get a rough idea of your home’s worth. Several national online real estate companies offer calculators that will estimate the home’s value based on similar sales in your neighborhood.
Once you have figured out the market value of your home, you can now determine how much you’ll be able to borrow against it. Again, many lenders that offer calculators that will do most of this work for you. It is a matter of plugging in the values of your home’s worth and existing loan balance, and the calculator will spit out an estimate of the amount you can potentially borrow, according to their product offerings.
Before you visit a lender or one of these online sites, however, it can be helpful to try to figure out your home’s loan-to-value (LTV) ratio. This is the outstanding balance of your loan divided by the value of the property.
Lenders are typically reluctant to extend a credit line or second mortgage unless you have hit a certain equity target. You can usually get a rough idea of whether you meet this target by calculating your loan-to-value ratio.
How to calculate LTV
Let’s consider an example where your home is worth $100,000 and your mortgage is $75,000. To calculate your LTV, your equation would look like this: ($75,000/$100,000 = 0.75 percent). This means that your loan-to-value ratio is 75 percent, and you have an equity level built up in your house of 25 percent of the home’s value. In the case of a home valued at $100,000, theoretically you would have $25,000 in equity to potentially tap.
Lenders typically don’t extend a credit line that taps out all the equity in your home. Many lenders will allow you to tap only as much as 85 percent of the equity in your home, but the amount largely depends on your credit history and income.
Lenders often don’t extend any line of credit unless your loan-to-value is 80 percent. In other words, you should have gained at least 20 percent equity or more in your home to be considered. Otherwise, you’ll probably have to wait for your property values to rise or to pay down more of your mortgage.