It is generally assumed that most people know what their home equity is. However, many people are still confused about the topic. As a homeowner, you need to understand how home equity works. That is especially true if you are looking to refinance a mortgage or borrow money against your residence.

Key Takeaways

  • Home equity is the value of your ownership stake in your home, calculated by subtracting your outstanding mortgage from the property's market value.
  • 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 restricted access to home equity and raised credit score requirements, especially for home equity lines of credit (HELOCs).

How Much Home Equity Do You Have?

Your home equity value 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. Suppose that 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'll come up with $100,000 in home equity.

How Big a Home Equity Loan Can You Get?

Very few lenders will let you borrow against the full amount of your home equity. They generally allow you to borrow a maximum of 80% to 90% of available equity, depending on your lender, credit, and 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. Race, national origin, and other nonfinancial considerations should never play a role in determining how much home equity you can borrow.

Mortgage lending discrimination is illegal. If you think you've been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report to the Consumer Financial Protection Bureau or the U.S. Department of Housing and Urban Development (HUD).

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. Furthermore, a recent appraisal or assessment placed the market value of your house at $250,000. You also still have $195,000 left on the original $200,000 loan. Remember, almost all of your early home mortgage payments go toward paying down interest.

If there are no other obligations tied to the house, you have $55,000 in home equity. That equals 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 that you had also taken out a $40,000 home equity loan in addition to your mortgage. The total indebtedness on the property is $235,000 instead of $195,000. That changes your total equity to just $15,000, dropping your home equity percentage to 6%.

Transaction Costs

Real estate is one of the most illiquid assets, so there is usually a cost associated with tapping into your home equity. If you actually sell the house, total closing costs are typically between 2% and 5% in the United States. Buyers usually pay many of these charges, but be aware that they could use these fees as an excuse to negotiate a lower sale price.

If you take out a home equity loan, you will probably have to pay some type of loan origination fee. Interest rates are also generally higher for second mortgages and home equity lines of credit (HELOCs) than for the original mortgage. After including these transaction costs, the amount of home equity you can really use is lower than the amount you have in theory.

The Loan-to-Value Ratio

Another way to express equity in your home is through the loan-to-value ratio (LTV ratio). It 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 in, it climbs to 94%.

Potential lenders use the LTV to determine whether or not to approve your applications for additional loans.

Lenders don't like a high LTV because it suggests you could have too much leverage and might be unable to pay back your loans. During times of economic upheaval, they can tighten their lending standards. That happened during the global coronavirus crisis. Especially for home equity lines of credit (HELOCs), banks raised their credit score requirements from the 600s to the 700s. They also lowered the dollar amounts and the percentage of home equity that they were willing to 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. Prices don't always go up. The long-term impact of the coronavirus crisis on home equity remains uncertain.