It's normally assumed that most people know what their home equity is, but many are still confused about the topic. As a homeowner, you need to understand how home equity works, especially if you are looking to refinance a mortgage or want to borrow money against your residence.
- Home equity is the value of your ownership stake in your home, calculated by subtracting your outstanding mortgage from the market value of the property.
- Few lenders will let you borrow against the full amount of your home equity.
- Under normal economic circumstances, you might be able to borrow between 80% and 90% of your available equity.
- During the coronavirus pandemic, lenders are restricting the percentages and dollar amounts borrowers can access and raising their credit score requirements, especially on home equity lines of credits, or HELOCs.
How Much Home Equity Do You Have?
The value of your home equity is the difference between the current market value of your home and the total sum of debts (mainly, your primary mortgage) registered against it.
The credit available to you as a borrower through a home equity loan depends on how much equity you have. So if your home is worth $250,000 and you owe $150,000 on your mortgage, simply subtract your remaining mortgage from the home's value and you come up with $100,000 in home equity.
How Big a Home Equity Loan Can You Get?
Very few lenders will allow you to borrow against the full amount of your home equity. Instead, they will generally allow you to borrow a maximum of 80% to 90% of your available equity, depending on the lender, your credit, and your income. So, if you have $100,000 in home equity, as in the example above, you could get a home equity line of credit (HELOC) of $80,000 to $90,000.
Here's a second example that takes into account 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. (Remember, almost all of your early home mortgage payments are used to pay down interest.)
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% ($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 ask for another loan or want to refinance.
The Importance of the Loan-to-Value Ratio
Another way to express equity in your home is through the loan-to-value (LTV) ratio. This is calculated by dividing the remaining loan balance by the current market value. Using the second example described above, your LTV is 78%. (Yes, it's the flip side of your home equity percentage of 22%.) With your $40,000 home equity loan thrown it, it climbs to 94%.
Lenders don't like a high LTV because it suggests you might be overleveraged and unable to pay back your loan(s). During times of economic upheaval, they can tighten their lending standards; that's what's happening with the current global coronavirus crisis. Especially for home equity lines of credit (HELOCs), banks are raising their credit score requirements from the 600s to the 700s and lowering the dollar amounts and the percentage of home equity that they'll lend.
Both LTV and home equity values are subject to fluctuations when the market value of a home changes. Millions of dollars in supposed home equity were wiped out during the subprime mortgage meltdown of 2007–2008. It remains to be seen what the effect of the coronavirus pandemic will be on home equity, both in the U.S. and around the world.