Even though it is normally assumed that most people know their home equity, many are still confused about the topic. And it is an important topic to understand, especially if you are looking to refinance a mortgage or want to borrow money against your residence.
The value of your home equity is the difference between the current market value of your home and the total sum of debts (mainly, though not exclusively, your primary mortgage) registered against it.
Simply stated, home equity is the value of your ownership stake in your home.
How Big of a Home Equity Loan Can You Get?
The credit available to a borrower through a home equity loan depends on how much equity you have—which is the current value of your home minus the balance owed on your mortgage. So if your home is worth $250,000 and you owe $150,000 on your mortgage, you have $100,000 in home equity.
However, very few lenders will allow you to borrow against the full amount of your home equity. Lenders will generally allow you to borrow up to 75% to 90% of your available equity, depending on the lender, your credit, and your income. Thus, in the aforementioned example, you could get a home equity line of credit of up to $80,000 to $90,000.
Here's another example that considers a few more factors. Suppose you are five years into a 30-year mortgage on your home. A recent appraisal or assessment places the current market value of your house at $250,000, and you still have $195,000 left on the original $200,000 loan. (Almost all of your early home mortgage payments are used to pay down interest, remember).
If there are no other obligations tied to the house, you have $55,000 in home equity, or the $250,000 current market value minus the $195,000 in debt. You can also divide home equity by the market value to determine your home equity percentage. In this case, the home equity percentage is 22%, or $55,000 ÷ $250,000 = .22.
Now, let's suppose, in addition to your mortgage, you had also taken out a $40,000 home equity loan. The total indebtedness on the property is $235,000 instead of $195,000. This changes your total equity to just $15,000, dropping your home equity percentage to 6%.
LTV is a very important figure for lenders when you go asking for another loan or to refinance.
Another way to express equity in your home is through the loan-to-value (LTV) formula. This is calculated by dividing the remaining loan balance by the current market value. Using the same initial example as before, your LTV is 78%. (Yes, it's the flip side of your home equity percentage of 22%.) With your home equity loan thrown it, it climbs to 84%.
Lenders do not like a high LTV because it suggests you might be overleveraged. Both LTV and home equity values are subject to fluctuations when the market value of your home changes. For example, millions of dollars in supposed home equity were wiped out during the subprime mortgage meltdown of 2007–2008.