Even though it is normally assumed 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.
Simply stated, home equity is value of your ownership stake in your home: the difference between its current market value of your home and the total sum of debts (mainly, though not exclusively, your primary mortgage) registered against it.
Figuring Your Home Equity
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%.
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%.
LTV is a very important figure for lenders when you go asking for another loan or to refinance. They 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.