How to calculate home equity
To calculate home equity, take the amount your property is currently worth, or the appraised value, and subtract the amount of any existing mortgages on your property.
For example: A home's appraised value is $600,000 – Amount owed on mortgage is $250,000 = $350,000 Equity.
refinance.
Read on to learn more about how to calculate home equity.
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Call 866.287.6225 today to schedule a no-obligation consultation and learn about our home equity lines of credit, auto loans, personal loans, checking and savings accounts, and other banking products. As a full-service financial institution, we look forward to helping you with all your banking needs.
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What is home equity?
Home equity or equity in a house refers to the difference between the balance on your mortgage and the market value of your home; it is the amount of your home that you own that is not encumbered by a first or second mortgage loan.
For example, if you do not have a mortgage, then you have 100% equity. If you have a mortgage, the lender "owns" part of your home. As you pay off your mortgage your equity (ownership) increases.
What is home equity and how does it work?
Home equity is the dollar amount or value of the home that you own based on how much you owe on your mortgage and any other secured loans that use your house as collateral.
As discussed earlier, if you
do not have a mortgage on your home then you have 100% equity in the home. People who have a first and/or second mortgage own only a percentage of their home. The lender who holds the mortgage also owns a percentage of the home.
If you have a mortgage, as you make payments toward the principal amount owed (not the interest owed) your loan balance decreases and your equity increases until the mortgage is paid in full, and you have 100% equity.
Using the equity in your home gives you access to cash that can be used any way you choose.
How to determine equity in home
Many homeowners want to know how to determine equity in their home. Equity is the amount of the home you own, minus any mortgage debt, such as a first or second mortgage.
Home equity loans are considered a second mortgage, and HELOCs are also a type of
second mortgage.
Calculating equity is easy, just follow these steps:
Determine the value of your home
Like getting a mortgage, getting approved for a HELOC requires a home appraisal to determine the market value of your home. The home value will be used in the formula below, to determine home equity and how much of a HELOC you can get approved for.
Find out how much you owe
Look at your most recent mortgage statement to see the principal balance owed. This number will also be used in the home equity calculation.
Subtract your loan balance from home value.
For example:
Appraised home value $600,000 – Amount owed on mortgage $250,000 = $350,000 equity.
Divide the equity ($350,000) by the home value ($600,000), which is 58% equity.
Calculate how much you can borrow
To calculate how much you can borrow in a home equity loan or HELOC, lenders look at a borrower's
loan-to-value (LTV) ratio, combined loan-to-value (CLTV) ratio,
debt-to-income (DTI) ratio,
credit score, and other factors.
Understanding LTV and CLTV
LTV. First, let’s look at the role that
loan-to-value (LTV) ratio plays in getting a home equity loan or a HELOC. The LTV ratio is a comparison of the amount of the loan to the value of the property. LTV is calculated by the lender during the loan application process and is used to assess lending risk. If the LTV is too high, the loan is considered high risk. The typical LTV for a home equity loan or HELOCs is 80%, although some lenders may accept a higher percentage.
LTV = Current loan balance ÷ Appraised home value
Example: You have a loan balance of $200,000. Your home appraises for $500,000.
Your loan-to-value equation is: $200,000 ÷ $500,000 = .40
To convert a decimal to a percentage, multiply by 100 (move the decimal point two places to the right).
Next, convert .40 to a percentage, which gives you a loan-to-value ratio of 40%.
In this example the homeowner would qualify for the loan.
CLTV. The combined loan-to-value (CLTV) ratio is calculated by adding the amount of the current mortgage balance to the borrower’s other debts secured by the home (such as a HELOC or home equity loan), plus the potential new loan amount. Most lenders require a CLTV ratio below 85% to qualify for a home equity loan or line of credit.
CLTV = Current combined loan balance ÷ Appraised home value
Example: You currently have a loan balance of $200,000 and are applying for a $50,000 HELOC. Your home is appraised for $500,000.
$250,000 ÷ $500,000 = .50
Next, convert .50 to a percentage (multiply by 100), which gives you a CLTV of 50%.
In this example the homeowner would qualify for the loan.
Pros and cons of using home equity
Pros
Low interest rates. All HELOCs start with a low variable interest rate that typically stays in effect for 10 years, which is called the draw period. Home equity loans and HELOC interest rates are lower than credit card rates, which means if you plan to pay off your loan over time, you'll likely pay less in interest using a HELOC or a home equity loan.
Tax advantages. According to the
IRS, interest on home equity loans and lines of credit are deductible only if the borrowed funds are used to buy, build, or substantially improve the taxpayer’s home that secures the loan. The loan must be secured by the tax-payer’s main home or second home (qualified residence) and meet other requirements.
Flexible spending. Use only the amount you need, just like a credit card.
Higher credit limit than credit cards. The credit limit amount a borrower can receive through a home equity loan or HELOC is largely determined by the amount of equity the borrower has in their home, credit score, and other factors. Qualified borrowers with ample equity may be able to get approved for amounts up to $1,000,000.
Cons
Interest rates may rise. While home equity loans have a fixed interest rate, HELOCs start with a variable rate that changes to a higher fixed rate after the draw period ends. Some homeowners who choose a HELOC find they are unable to pay the adjusted rate in addition to paying down the principal amount of the loan.
Fees. Lenders may charge a pre-payment penalty, annual fee, or inactivity fee if you don’t use the loan.
Home value drops. If the value of your home decreases, that means you’ve lost equity and could owe more than your home is worth.
Damage to your credit. If you fail to repay the loan, make late payments or are unable to make your first mortgage payments, these events will be reported to the credit bureaus and your credit score will go down.
Loan collateral. Home equity loans and HELOCs are secured by the equity in your home (i.e., uses your home as collateral), defaulting can result in the lender foreclosing on your home.
How to get equity out of your home
Utilizing your home equity begins by knowing how much equity you have in your home. To do this, you may use the formula provided in this article.
Prepare to meet the lender's HELOC requirements:
Here are some
general requirements that most lenders will look for when evaluating a borrower’s loan application:
- Equity of at least 15% to 20%
- A minimum credit score in the mid-600 range
- Low debt-to-income (DTI) ratio. Most lenders require a DTI ratio of 43% to 50%
- Sufficient income
Next, shop for a lender. Compare the interest rates and loan terms to find the HELOC that's right for you. Credit unions, including Credit Union of Southern California, have some of the
best HELOC rates and terms.
What can home equity be used for?
Once approved for a HELOC, you can use the money any way you want. Some common uses are for making home renovations, paying for college, covering expensive medical bills, unexpected travel, or job loss, paying off high interest debt (such as an auto loan or an increasing credit card balance), and even
buying an investment property or second home.
What shouldn't I use my home equity for?
Due to the cost of borrowing money, it's financially wise to use the money for things that will put you in a better financial position. This means not using the money for luxury purchases, such as clothing, vacations, electronics, home furnishings, or risky investments.
How quickly can I access my home equity after purchasing?
If you are a new homeowner, you may be able to start taking equity out of your home shortly after your first mortgage closes. For example, you may
get a HELOC 30-45 days after the purchase of a home. However, borrowers will need to meet all the necessary lender requirements, including 15-20% equity in home, good repayment history, and more.
How can I increase the equity in my home?
Increasing equity in your home depends on your current mortgage loan amount and how much extra money you put toward paying down your loan amount. Economic factors, such as your home's market value also affect equity.
Is accessing your home equity worth it?
If you need a large chunk of cash for a home renovation, a wedding, or to pay off large medical bills, taking equity out of home through a home equity loan or a HELOC can be a great way to use your home to get the cash you need. However, taking equity out of your home is a big financial responsibility that requires the income and commitment to repaying the loan on time and in-full, so as not to risk foreclosure by the lender.
Why Savvy Consumers Choose CU SoCal
For over 60 years, CU SoCal has been providing financial services, including HELOCs, car loans, personal loans, mortgages, credit cards, and other banking products, to those who live, work, worship, or attend school in Orange County, Los Angeles County, Riverside County, and San Bernardino County.
Please give us a call today at 866.287.6225 today to schedule a no-obligation consultation with one of our HELOC experts.
Get Started on Your Home Equity Line of Credit Today!