At some point during home ownership, you’ll want to know how much equity you have. It shows you how much money you have invested in the home and gives you a good estimate of what you would make if you sold the home.
You don’t have to be in the market to sell your home or even refinance your loan to determine the amount of equity. It’s just a nice number to know should you ever need to fall back on it. But, if you pay Private Mortgage Insurance on your loan right, now, this number could be very valuable to you as it could be the figure you need to cancel PMI.
Determining Your Equity
In order to determine your home’s equity, you’ll first need an accurate value of the home. If you want a ballpark estimate, you can use an online estimator, such as Zillow. If you want an accurate number, you may want to pay for a professional appraisal.
Once you know the home’s value, you can subtract from it any home loan balances you carry. This includes all first and second liens. If you have any home equity loans or lines of credit, make sure you include the full balance of those loans in your calculation.
Here’s an example:
Joe’s home is worth $400,000. Joe has a first mortgage balance of $200,000 and a home equity loan with a balance of $100,000. Joe’s home equity is:
$400,000 – $200,000 – $100,000 = $100,000
Joe has $100,000 in home equity. If he were to sell the home today, he would walk away with that $100,000, minus any costs that he incurs by selling the home.
Basically, the home’s equity is the money that is free from any outstanding debts that use the home as collateral.
Another Way to Look at the Equity
Another way to measure a home’s equity is to look at the home’s value versus the amount of money outstanding in home loans. Lenders call this the loan-to-value ratio.
Using the above example, Joe’s home was worth $400,000 and he had $300,000 in total outstanding loans. Joe’s loan-to-value ratio is then:
$300,000/$400,000 = 75%
This means that 75% of the value of Joe’s home is tied up in loans. The remaining 25% is his equity. $400,000 x .25 = $100,000.
You likely heard the loan-to-value term a lot when you first took out your loan. It’s the maximum percentage a lender will allow on a home loan. For example, the FHA loan allows a maximum LTV of 97.5%. This means borrowers must put down at least 3.5% on the home. Conventional loans, on the other hand, require at least 5% down with a 95% LTV. If you want to avoid PMI, you’ll have to put down at least 20%, with a maximum LTV of 80%.
One of the greatest advantages of knowing the amount of equity you have in your home is the ability to eliminate PMI. If you currently pay this fee, pay close attention to the LTV of your loan. It may change quicker than you think of the home appreciates in value or you make extra payments towards the balance of your mortgage.
By law, lenders have to cancel your PMI once you owe less than 78% of the home’s value. If you hit below 80%, though, you are free to request that the lender cancel the PMI. You’ll have to pay for a new appraisal so that the lender can verify that you do have at least 20% equity in the home, but that $400 – $500 fee will likely save you thousands of dollars in insurance premiums, so it is often worth it.
Tapping Into Your Home’s Equity
Tapping into your home’s equity is possible if you have more than 20% of your own money invested. You can get access to the cash by securing a home equity loan or line of credit. Typically, lenders allow an LTV of up to 85% when taking cash out of the home. In Joe’s case, he could take out up to $40,000 in a home equity loan or line of credit and still hit that 85% threshold.
Of course, whether you can qualify for a home equity loan or line of credit depends on more than your LTV. The lender will determine if you can afford the loan by looking at your current debts and income. They will also evaluate your credit score and credit history to ensure that you are a good risk.
The bottom line is that your home equity can do a lot for you. It can give you a good measure of your investment, giving you peace of mind that you have an emergency fund should you need to tap into it. It can also help you eliminate PMI or even secure a home equity line of credit to have access to the cash that is now yours.