Home equity is one of the most valuable assets that a homeowner can access. But far too few homeowners know how to calculate home equity and how to determine how much they can take out through a loan or cash-out refinance.
Today, let's break down how to calculate home equity differently.
You need to know how to calculate the equity you have in your property to use it effectively.
Your home equity is your ownership stake in your property. You increase it through various methods, primarily by making regular mortgage payments toward the principal amount you owe on the mortgage.
If you know how to calculate the equity in your property, you’ll know:
That’s essential information, particularly if you need to dip into your equity for debt purposes and unexpected bills. There are two different ways in which you can calculate equity.
The streamlined equity calculation is as follows:
The formula looks like this:
Let’s take a look at an example. Say that you owe $150,000 on your mortgage, and your home’s recently appraised value is $500,000.
Plug those numbers into the formula, and you get:
This way, you can calculate that you have about $350,000 worth of equity. You can also, of course, turn this into a percentage. With the above example, you have about 70% equity. In this hypothetical example, you would have a 70% ownership stake in your property.
You can also look at this another way. Your current mortgage balance tells you the equity you don’t own in your real estate investment. Depending on your interest rate and the amount of equity you currently have, you could make extra payments to reduce your loan amount even further.
Not only will this boost your credit score, but it will also open up additional home-equity products to use for home improvement projects, paying high-interest debt, and other financial decisions.
However, you can also calculate equity as the banks do, usually via the loan-to-value or LTV ratio.
The loan-to-value ratio tells a bank how valuable a potential mortgage loan is relative to a property’s appraised value. If you already have a mortgage, the LTV ratio is instead based on your current loan balance.
Knowing the LTV ratio is important because it affects whether you pay private mortgage insurance (PMI) or qualify for options like refinancing your loan. A higher LTV ratio indicates a greater risk, while a lower LTV ratio represents a lower risk.
To calculate the LTV ratio:
Let's keep the same example described above, with a $500,000 property and a primary mortgage with $150,000 still owed by the homeowner.
In this case, the loan-to-value ratio would be 30%.
In a traditional refinance, homeowners can take out up to 20% of their equity, so in this instance, the homeowner would have access to 50% if their debt to income allows for the higher balance.
LTV is the inverse of the amount of equity held by the borrower. So, 100 - 30 = 70%. They can't take out more than 20%, so 70 - 20 = 50%.
Knowing how to calculate equity is one thing. Knowing how to increase it so you get better home equity lines of credit and loan options is another.
Luckily, there are lots of different ways in which you can increase equity. Here are a few examples:
Balance Homes is a co-ownership solution with a mission to help American homeowners stay connected to the homes they love by offering a flexible alternative to traditional financing when life circumstances change. Our model also focuses on long-term financial health and education, helping homeowners understand their options, manage their equity, and build a plan that fits their needs.
Ready to get started? Get your free proposal today.
Sources:
Understanding your home's equity | Freddie Mac
How to calculate your home equity | Bank of America
Loan-to-Value (LTV) Ratio: What It Is, How to Calculate, Example | Investopedia
