Today in this post we will learn how to calculate home equity and understand the list of factors involved and superior guide to build equity in your home.
If a person plans to sell or refinance their home it is important for them to understand the amount of equity they have in their home.
When selling a house, the ultimate goal of everyone is to profit from its equity. In real estate, the term home equity means a home’s value relative to what’s owed on it.
If a home is sold for more than what one owes, it is positive equity. Likewise when the home is sold for less than what one owes, then they are in a negative equity situation.
It is obvious that the ideal time to sell a house is when one can make a profit.
The difference between the appraised value of a home and the amount one still owes on their mortgage is the home equity.
The amount of equity one has in the home influences their finances in many ways – like whether they need to pay private mortgage insurance, what financing options are available for them, etc.
Home equity = Current appraised value – mortgage balance.
To identify their home equity one needs to deduct the amount they owe on all loans secured by their house with the home’s appraised value.
If the appraised value of the home is lower than what they owe on their mortgage, then it is an underwater mortgage meaning they would not have any equity in their home.
To make a decision about loans and financing the most common measure lenders may use is the loan-to-value ratio (LTV).
When a borrower first applies for a mortgage, this equation compares the amount of the loan they are expecting to the home’s value.
If the borrower has a current mortgage, their LTV ratio would be based on their loan balance.
LTV ratio is the deciding factor if a customer is required to have private mortgage insurance (PMI) or if they can qualify to refinance.
To know their LTV ratio, a homeowner should divide their current loan balance (which can be found on their monthly statement or online account) with the home’s appraised value. to convert it to a percentage that number should be multiplied by 100.
Loan to value ratio = current loan balance / current appraised value X 100
To determine one’s loan to value ratio it is ideal to get a professional appraisal of the home done.
A lender can arrange for a qualified appraiser to come to your home and assess its value to get an on-site appraisal done.
To determine what your home is worth, a home appraisal is the most accurate way, but there are other free online tools that can also provide an estimate of your home’s value.
In the event a homeowner defaults on their mortgage then PMI which is actual insurance protects a lender.
Who needs to pay PMI? If a borrower’s down payment was less than 20 % of the home’s purchase price, then the lender may have required private mortgage insurance on their original mortgage.
The requirement of private mortgage insurance exists only when the loan-to-value ratio is above a certain threshold.
When a home’s LTV ratio is 78 % or lower and if certain requirements are met then the Homeowners Protection Act requires lenders to automatically cancel PMI.
When the loan balance reaches 78 % of a home’s original appraised value then this cancellation is often preplanned.
However, if a borrower has made extra payments then they have the right to request their lender to cancel the PMI if their LTV ratio drops below 80 % before the schedule.
If a borrower is considering a home equity loan or line of credit, then their combined loan-to-value ratio (CLTV) is another important calculation.
The CLTV ratio evaluates the value of the borrower’s home to the combined total of the loans secured by it, counting the loan or line of credit that they are looking at.
A combined loan to value ratio (CLTV) = Current loan balance + HELOC / Current appraised value.
Even though the CLTV ratio requirement may vary from lender to lender but most lenders require the CLTV ratio to be below 85 % to qualify for a home equity line of credit.
But the home’s value can fluctuate over time so if the value drops, they may not be eligible for a home equity loan or line of credit, or they may end up unsettled more than what their home is worth.
Equity can be built by paying down the loan’s principal and lowering one’s loan-to-value ratio.
If the payments are amortized meaning if it is based on scheduled monthly payments by which one repays their loan in full by the end of its term then paying it regularly without default.
To lower one LTV ratio and increase their equity more quickly, a borrower can consider paying more than the required mortgage payment each month.
This helps in finishing the loan balance faster. However one needs to make sure that the loan doesn’t carry any prepayment penalties.
A borrower can also protect the value of their home by keeping it well-maintained. Making improvements to the home may also increase its value and thereby increase the home equity.
Before investing in any renovations it is suggested that the borrower consults an appraiser or real estate professional to get a better estimate of how it will impact the value of a home.
Home equity means a home’s value relative to what’s owed on it. It is important to understand that immaterial of any changes sometimes economic conditions can affect the home’s value.
If home prices boost, the LTV ratio could go down, and thereby increasing the home equity, the falling home prices could terminate the value of any improvements that a borrower would have made.
When you’re a homeowner, the mortgage payments that you make every month can help you build a powerful asset which is your home equity.
The home equity acts as the amount of your home that you own, and it keeps growing over a period of time.
Home equity is the portion of your home that you own, which is calculated by knocking off your mortgage balance from the home’s market value.
So if the value of your home is $250,000 and if you owe $150,000 on your mortgage, then your home equity, would be
$250,000 – $150,000 = $100,000.
It is advisable to know how much equity you have because the borrowing amounts are set by your lenders based on the amount of equity you own.
You can either increase your property value or decrease your mortgage debt to build home equity.
The difference between the current market value of a property and the principal balance of all outstanding loans is how home equity can be defined.
When your mortgage balance is subtracted from the market value of your home you get the calculation of equity.
It is important to build home equity because, if need be it can be converted into cash through a home equity loan or a line of credit or cash.
To increase your home’s equity, you must increase your home’s value, and reduce your mortgage debt. Let us look at a few options:
Down payments provide instant equity and kick starts the equity you build, the bigger the down payment, the more equity you have to start with.
If you’re able to put down a 20%, you can avoid having to pay private mortgage insurance, also known as PMI.
However, when determining the ideal amount of money to put down for you and your situation it is important to assess your finances and financial goals.
You must also consider how much savings you’ll have left after closing. It may be harder to handle financial emergencies or your regular monthly payment if you’re left with little to no cash reserves.
Most mortgages are on an amortization schedule where your payments are made to cover both principal and interest in equal installments for a specified period of time till your loan is paid off.
Generally, in the beginning, a larger portion of your payment goes towards interest, and then over time more goes towards the principal. Consider paying more than you have to if it suits your pocket.
By doing this, you decrease your outstanding loan balance faster, as a result increasing your equity.
While doing this make sure the extra money you pay goes to cover the principal, and not towards the interest.
There are some ways to pay extra money on your mortgage, like adding a fixed sum to your payments each month, or switching to a biweekly mortgage schedule, or scheduling extra payments at regular intervals, and if receiving extra money such as tax refunds and tax gifts then using it to pay extra.
There are 2 benefits of a shorter-term loan. Choosing for refinancing to a shorter loan term can help boost your equity.
When you opt for a 15-year mortgage, you get a lower interest rate, and also a larger portion of your payments goes towards principal rather than interest.
Compared to a 30-year mortgage this increases the amount of equity you build each month.
But the catch is that with a shorter-term loan payments are also higher, so you should plan and identify if there’s room in your budget for larger payments.
Making key home improvement projects like remodeling can boost your equity. According to Remodeling Magazine, the average payback on the most common upgrades is a 64% return on your investment.
Smaller projects, such as garage door replacements, can do a good job of increasing your equity, more so when you pay with cash rather than through a loan.
It’s important to consider how much the improvement will enhance your living experience within the home unless you’re remodeling with the intention of selling your home.
Before taking on the remodel consult with a real estate agent or other homes professional to determine which type of renovations will net you the highest return.
You can simply be patient and wait for the home equity to go up if you’re not in a rush to build equity. The housing market fluctuates and so does your home’s value.
Local market conditions impact the value of your home naturally resulting in your home value varying; your home value will rise when the home prices increase and demand goes up in your area.
On the contrary, if the market slows, your home value may go down and you may lose some equity with it. These market changes are not in your hands to control, but they’re worth keeping in mind.
To get an idea of your home’s current value at any given time you can consult an appraiser or use an online estimating tool.
It may take some time to build equity, but it’s definitely beneficial; you can draw from your asset using a home equity loan or home equity line of credit once you have enough equity.
Making a bigger down payment, improving your property value paying more toward your mortgage every month, and trying to pay off in a shorter-term are just a few ways to start growing your equity.