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How to Calculate Home Equity, and Why You’d Want To
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Knowing how to calculate your home equity in various scenarios can help you determine how to use that equity toward your financial goals. The math is simple: Subtract your home’s value from any mortgage balance you owe, and the difference is your home equity amount. However, that figure can change if you plan to borrow against your equity or sell your home.
How much home equity do you have?
There are basically three ways to calculate your home equity. The first is just deducting how much you owe from what you think your home is worth. For example, if you estimate your home is worth $350,000 and you owe $200,000, you have $150,000 worth of home equity ($350,000 – $200,000 = $150,000).
The other two methods depend on whether you plan to borrow against your home equity or sell your home — We’ll cover both below.
How to calculate home equity for a cash-out refinance or second mortgage
If you want to tap some of your home equity, your lender will do the home equity calculations based on three criteria: your home’s appraised value, your verified loan balance and the maximum loan-to-value (LTV) ratio requirements for the type of mortgage you’re taking out.
Appraised value. An unbiased, licensed third-party home appraiser deep dives into all of your home’s characteristics, which are then compared to similar homes nearby to deliver an “opinion of value.”
Current mortgage payoff balance. Lenders order a payoff statement from your current lender and use the exact amount when determining how much you’ll net back.
Maximum LTV ratio. The amount you borrow compared to your home’s value is called your LTV ratio, and it measures how much of your home’s value is borrowed as a percentage. The maximum LTV ratio varies depending on the type of loan you apply for. For example, if you apply for a conventional cash-out refinance, the max LTV ratio is 80%.
Here’s how you’d calculate the total equity you could take home (before closing costs) on a home worth $350,000 with a $200,000 mortgage balance.
Home equity for a mortgage calculation example
|Multiply by 80% maximum LTV ratio||x 0.80|
|Maximum loan amount||$280,000|
|(Minus current mortgage payoff balance)||– $200,000|
|Home equity you can borrow||$80,000|
Bottom line: The lender’s LTV ratio guidelines limit you to borrowing $80,000 worth of your $150,000 home equity. One caveat: When you borrow from your home equity you convert it to debt that you’ll have to pay off when you sell your home.
How to calculate home equity if you plan to sell your home
The only way to truly know how much home equity you have is to look at the bottom line after all the costs of selling your home are deducted. Until you accept a buyer’s offer, follow these steps to make an educated guess about your home equity for a home sale:
- Get a comparative market analysis (CMA). Your real estate agent typically prepares this detailed report. The CMA compares your home to similar properties nearby that have recently sold to give you a more educated guess about your home’s value.
- Subtract real estate sales commissions. Although real estate commissions vary, you should budget for 6% of your sales price, since you’ll typically pay commissions to all real estate agents that help sell your home.
- Subtract estimated closing costs. Even if you find a cash buyer, you’ll still pay title insurance fees, inspection fees and ownership transfer costs that usually run between 2% and 6% of your sales price.
- Subtract home staging and inspection fees. Depending on your home’s size, it might cost you between $752 and $2,827, according to HomeAdvisor, to stage your home for prospective buyers. You’ll pay another $300 to $500 for inspection fees to make sure everything from the floor to the roof is in good working order.
- Subtract any loan balance you have. If you owe any money on your home, you’ll need to request a payoff statement to pay the balance in full.
Here’s how your home equity math rolls out using the costs we’ve detailed above, assuming the $350,000 sale above with a $200,000 mortgage owed.
Home equity for a home sale example
|Subtract real estate commissions (6%)||– $21,000|
|Subtract closing costs (2% to 6%)||– $7,000 to $21,000|
|Subtract home staging and inspection fees||– $1,052 to $3,327|
|Subtract current mortgage balance||– $200,000|
|Home equity converted to cash||$104,673 to $120,948|
Bottom line: Selling your home is the only way to truly know how much home equity you have. However, you should discuss the tax benefits of selling your home with a tax professional, and you’ll also need to plan where you’d live after the sale.
How much home equity can you borrow?
There are three standard loans that allow you to borrow your home equity: a cash-out refinance, a home equity loan or a home equity line of credit (HELOC). A cash-out refinance is a home loan that you take out for more than you currently owe and pocket the difference in cash. You can take cash out on a conventional, FHA or VA loan.
Home equity loans and HELOCs are second mortgages, as they’re secured behind your current first mortgage. With a home equity loan, you receive funds in a lump sum and typically make a monthly fixed-rate payment. In contrast, a HELOC is like a credit card on your home: You can use funds, pay them off and reuse them for a set time, usually 10 years.
Compare the maximum LTV ratios for each type of equity-tapping mortgage below:
|Mortgage type||Maximum LTV ratio|
|Conventional cash-out refinance||80%|
|FHA cash-out refinance||80%|
|VA cash-out refinance||90%|
|Home equity loan||85%|
What can you do with your home equity?
The ultimate goal of homeownership should be to have a home free of debt, so you have shelter you own and can pass down to future generations. Besides the financial benefit, having a mortgage-free home eliminates the possibility of losing your home to foreclosure if you fail to repay the loan.
However, there are some financial goals you can accomplish using your home equity, which include:
- Making home improvements
- Paying off high-interest credit cards
- Paying for a college education or wedding
- Building a real estate investment portfolio or buying a vacation home
How to build home equity
There are some very simple things you can do before and after you buy a home to help build your equity.
- Make a bigger down payment. The more equity you start with, the faster your equity will grow as your home’s value rises. A large down payment gives you a better home equity starting point.
- Pick a shorter term. If you can afford higher monthly payment, a shorter term like a 15-year fixed-rate mortgage will shrink your balance faster than the popular 30-year fixed-rate mortgage.
- Make extra payments whenever you can. Even one extra payment a year helps increase your available equity.
- Add value with repairs and improvements. Homebuyers often prefer homes that have been updated, and you’ll score extra points with home appraisers if your home is well-maintained and updated with home improvements — like modern flooring and fixtures — on a regular basis.