How much equity do I have in my home?
Wherever you are in your homeownership journey, it's important to understand the concept of "home equity" and what it means for your financial situation.
What is home equity?
Why is it important?
How do I calculate it?
Can home equity be negative?
What is the loan-to-value ratio?
How can I use home equity in retirement?
How do I protect my home equity?
How much can I borrow from my home equity?
Wherever you are in your homeownership journey, it's important to understand the concept of "home equity" and what it means for your financial situation. Growing your home equity is an important part of building long-term wealth, and can be a powerful tool for paying down debt, diversifying investments, and planning for retirement.
Here are some fast facts about equity’s role in your financial security and how you can calculate your home equity quickly.
What is home equity?
If you still pay a mortgage on your home every month, you are a homeowner, but you technically don’t own your home outright. The bank or lender who holds the deed to your house and collects your payment is the true owner. Until you’ve paid off every penny of that loan, you are working toward owning it in full – or having 100% equity in your home.
Home equity is your portion of ownership. As you pay down your mortgage balance over time, you get more and more equity.
Why is home equity important?
A homeowner’s ultimate goal is to own all of their home. They want 100% equity and to have their hands on that house title someday. In addition to the idea of owning your home free and clear, there are some financial benefits to having more home equity.
Home equity has value. It can be leveraged, like any property or asset, to help you secure loans or funding. You may have heard about home equity loans or lines of credit. These tools use the equity you’ve already built up in your home and use them as collateral to get even more funding. The more equity you have, the more funding you may be able to secure.
How do I calculate how much home equity I have?
Whether you plan on getting a home equity line of credit or not, it’s a good idea to know how much home equity you have at any time. While the formula is a simple one, finding the exact numbers to plug into the formula can be tricky.
That's because your home value is a significant factor in figuring out home equity, and we know that home value fluctuates and changes over time. Just look at the housing market today, and you'll notice that homes in some areas are going for much more than they did just two years ago. If you use the home value from 2019 to figure out your home equity, you'll end up with the wrong number.
Let’s look at the formula for home equity:
Appraised value of your home – amount you still owe on your home loan = home equity
An example would be a home recently appraised at $300,000 with an outstanding mortgage balance of $100,000. Your home equity would be $200,000 in this case.
To get a very accurate picture of home equity, you’ll need a recent appraisal from an experienced appraisal team. (If you plan on using your home equity to secure a loan, there may be additional requirements in finding an appraiser.) You will also use the total payoff amount for your home and not the number you see on your last mortgage statement. Lenders might need you to call to get the total payoff amount since interest and fees accrue daily and can affect the number in a very short time.
Can home equity ever be negative?
Unfortunately, the answer to this question is “yes.” It’s possible (and even common) to see homeowners owing more money on their mortgages than the home is worth. This is also called being “underwater” in your home. It’s not an ideal situation to be in, since it limits your financial possibilities and puts you at risk if you were to ever need to sell your home.
If you needed to move, for example, selling your home would not give you enough money to pay off the bank. It’s best to always get in a positive equity position with your home – as soon as possible. Negative equity places you in a tricky situation.
What is the loan-to-value ratio?
Another term closely related to home equity is the loan-to-value ratio (LTV.) It's a percentage that's used to communicate the same information you calculated when figuring out your home's equity. It can be used by lenders to decide a home equity loan amount, as well as the interest rate you'll pay. Sometimes, you may need to purchase private mortgage insurance, especially if you are taking out a big portion of your home equity. The LTV determines much of this.
Figure out your LTV by dividing your loan balance by your home’s appraised value. As in the example above, your LTV would be found by:
$100,000 / $300,000 = .33 or an LTV of 33%
Many lenders require your LTV to not be over a certain amount (90%, for example.) They'll use this number, along with your credit score and your ability to repay, to determine what size of loan they can give you.
How can I use my home equity in retirement?
So, we know that positive home equity is good and that it can be used in ways like getting a HELOC or reverse mortgage. This is especially useful for retirees, who have much different financial needs than they did in pre-retirement life.
Think of all the expenses that can pop up after 65. You have bills not covered by Medicare, payments for services that help you stay in your home, and even things you've put off all your life and finally get to do now (like that lifetime vacation in Hawaii.) All of these things cost additional money that may not be paid for by your retirement fund and Social Security alone.
That’s where a home equity line of credit can be very useful. How do home equity lines of credit work? By using the equity in your home to secure a lump sum payment from a lender, you can set some money aside for medical bills, get some repairs done on your home, refinance more expensive debt, and even take that well-deserved vacation. Some homeowners have even used the money to purchase a second home for the winter or as an investment property.
The possibilities of what to use a HELOC for are almost endless, which is why they are ideal for retirement when flexibility is a must, and may be better than cash-out refinancing.
How can I protect my home’s equity?
In the case of a declining market, your home value may dip – and there may not be much you can do about it. There are things you can do to increase equity, however, including making on-time payments and keeping your home well-maintained so that it doesn’t lose value on its own. (Using a HELOC to make home improvements is a solid option.) Before you make any significant changes to your home – or do a large remodel – ask an appraiser what it will do for your equity. Some improvements really don’t add that much value and may not be the best fit.
How much can I borrow against my home equity?
Using your home equity to finance other projects can make a big difference in your personal finance life. Just remember that it's not a dollar-for-dollar trade. Lenders usually offer you a percentage of your home's equity as a loan.
Whether you use your home equity to get money for an investment property or choose to save it for a rainy day, it can be very freeing to know that your home equity is there, ready to work for you. Fraction gives you the education to make the right decision, then makes the process of applying easy -- whether you are just in the research stage or have been considering your home equity for a while. Just put in your home’s address to see if it’s available in your area.