If you own a home, you can borrow against its value. That’s one way to drum up cash, without actually selling your house, in order to consolidate debt, finance a renovation or pay for an expensive purchase. Before you can tap into your home equity, however, you need to figure out how much you have.
“Most Americans’ biggest asset is their primary residence,” said Peter Shieh, a senior wealth advisor for US consumer wealth management at Citi. “So, it’s important to understand what home equity is and how it can be leveraged.”
How much equity do you have in your home?
There’s a bit of math involved in figuring this out, but it’s fairly simple. Here’s how to calculate your home equity in four steps.
1. Estimate the value of your home
Though mortgage lenders typically require a value estimate provided by a professional appraiser or public assessor, you can get a ballpark figure from your county assessor. They’ll have a figure on file for property tax purposes.
There are also online price engines, like Zillow and Redfin, that use an algorithm to determine a market value: An estimate of what a buyer would pay for your home given market conditions in your area.
2. Determine what you owe on your mortgage
Your monthly mortgage statement will show your balance: How much you still owe your lender on your mortgage.
3. Calculate your home equity
Here’s where the math comes in. Use this equation:
- Current home value – mortgage balance = Your home equity
For example, if your home is valued at $500,000 and you owe $300,000 on your mortgage, you have $200,000 in home equity.
How to calculate loan-to-value (LTV)
Once you know how much home equity you have, you can figure out how to borrow against it. Lenders use a loan-to-value ratio, or LTV, to determine your eligibility for a home equity loan or a home equity line of credit, or HELOC. Here’s how to calculate your LTV:
- Current mortgage balance / current home value = Your loan-to-value ratio
Lenders typically allow you to borrow up to 80% of your home’s value. If your home is worth $500,000, then you may be able to borrow up to $400,000, less any mortgages or debt carried by the property, according to Shieh. Loan-to-value requirements vary from lender to lender and are also based on your credit,” he said.
Pros and cons of using home equity
There are several major advantages to borrowing against your home instead of taking out a personal loan or running up credit card debt. You can leverage the increasing value of your property, secure a relatively low interest rate and use cheaper debt to finance home renovations or big-ticket expenses. And there’s a compelling bonus: Interest payments on a home equity loan or HELOC are tax deductible.
The major drawback is that you’re required to use your home as collateral, which can be a risky gambit. If the value of your home decreases, you may not be able to borrow as much against it. And some home equity loans have lengthy terms, which can mean paying more interest over time.
How to increase equity in your home
There are several ways to increase your home equity before you borrow against it. You can decrease your mortgage balance by making extra payments over the course of a year. You can try to increase the value of your home with a renovation or by enhancing its exterior or interior. You can also boost your equity by making a larger down payment, using the proceeds from the sale of a previous home. A higher reappraisal can also bump up your equity.