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How to Calculate Home Equity in 3 Steps
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If you’ve noticed homes selling in your neighborhood, you’ve probably wondered: How much equity do I have? Knowing how to calculate home equity, or the difference between your home’s value and your mortgage balance, will help you decide if it’s worth tapping to accomplish other financial goals.
How to calculate home equity
1. Get an estimate of your home’s value
Your home’s value is the most important factor in calculating your home’s equity. You can get a rough idea of how much your home is worth from an online home value estimator. However, you may get a more precise figure through other avenues, such as:
- Requesting a comparable 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.
- Ordering a home appraisal. For an unbiased, third-party opinion of your home’s value, a home appraisal might be worth the $300 to $400 price tag. A licensed home appraiser does a deeper dive into all the characteristics of your home. Appraisals are normally required for mortgage financing.
2. Check your loan balance
Your monthly mortgage statement is the best place to find current information about your loan balance. It also breaks down how much principal and interest you pay each month.
Your payoff amount and principal balance are slightly different. The principal balance doesn’t include interest due since your last payment. Mortgage interest is paid in arrears, meaning each monthly payment covers interest from the previous month. If you decide to pay your loan off, the lender will calculate your payoff balance, which includes your remaining principal balance plus interest.
3. Subtract your loan balance from your home’s value
To calculate your home equity, simply subtract your loan balance from your home’s value. Keep in mind the actual amount of home equity you can tap depends on a number of factors:
- The costs of selling your home. Real estate commissions and closing costs will cut into your net profit after your home is sold. If your home needs repairs before you market it for sale, those costs will cut into your bottom line as well.
- The lending limits if you’re refinancing. If you want to tap your home equity with a cash-out refinance for home improvements or debt consolidation, you’ll run into loan-to-value ratio limits. We’ll explain those next.
How your LTV ratio determines how much equity you can tap
Your current loan-to-value (LTV) ratio is calculated by dividing your loan balance by your home’s value. Once you know your current LTV ratio, you can use that figure to calculate how much home equity you can borrow. Most home loan programs limit you to tapping 80% of your home’s equity for a cash-out refinance.
Below are the steps you’d take using your LTV ratio to calculate how much money you’ll pocket with a cash-out refinance. The following example assumes you want to tap 80% of the equity in a $250,000 home with a current mortgage balance of $150,000.
Calculate your current LTV ratio
How to do it: Divide your current loan balance by your home’s value.
$150,00/$250,000 = 60%
What it means: This figure is your current LTV ratio. Because it’s less than 80%, you can tap up to 20% of your total equity. (80%-60% = 20% tappable home equity)
Calculate your cash-out LTV ratio
How to do it: Multiply your home’s value by your target LTV ratio.
$250,000 x 80% = $200,000
What it means: This reflects the maximum loan amount you can borrow based on your home’s value.
Calculate how much equity you can tap
How to do it: Subtract the maximum loan amount from your current loan balance.
$200,000-$150,000 = $50,000
What it means: You can borrow up to $50,000 of your home’s equity.
How to use your home equity
Borrowing against your home equity converts its cash value into debt. However, owning a debt-free home should be the ultimate goal of homeownership. 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.
The financial goals you can accomplish using your home equity include:
- Making home improvements
- Paying off high-interest credit cards
- Paying for a college education or a wedding
- Building a real estate investment portfolio or buying a vacation home
Home equity loan options
Cash-out refinance loans
How they work: You take out a new loan for more than you owe and pocket the difference in cash. The interest rates are typically lower than home equity loans and home equity lines of credit (HELOCs).
Home equity loans
How they work: You receive cash from a home equity loan in a lump sum, and make fixed-rate payments for a set term of typically five to 15 years. Use a home equity loan calculator to see how much you may be able to borrow.
Home equity lines of credit (HELOCs)
How they work: HELOCs are revolving lines of credit with a temporary draw period typically lasting five to 10 years. The HELOC payment is only based on the amount drawn, and interest-only payment options are common.