Your home equity can inform decisions regarding refinancing, applying for a home equity line of credit, refinancing your current home loan or even selling your house.
In this article, you can learn what you need to know about home equity, getting answers to your most important questions, including:
- What is home equity?
- How much equity do I have?
- What does a loan-to-value ratio mean for home equity?
- What is a home equity loan?
- How can I increase my home equity?
What Is Home Equity?
Home equity is the value you have in your home. If you own your home free and clear, then you have 100% equity in the home, and your home equity equals the current market value of your home. If you have a mortgage (or other financial liens against your home), your home equity equals the current market value of the property minus the amount currently owed on the loan.
Your home equity is essentially the proceeds you would receive if you sold your home today (ignoring any closing costs).
How Much Home Equity Do I Have?
To calculate your home equity, you need to know two figures:
- The current market value of your property
- The total balance due on any and all loans against your property.
How to Find the Market Value of Your Property
Valuing property is difficult because the real estate market is constantly fluctuating. The value of your property is directly tied to current market conditions. What is the amount that a buyer is willing to pay and that you are willing to accept in the current economic climate? This is a difficult question to answer.
And this is further complicated by the fact that each piece of real estate is unique. Even if you live in a planned development with identical homes, the geographic location and interior finishes of your home make your property one-of-a-kind.
This is why it’s so difficult to get an accurate home value estimate. You might find value estimates online, but those can be wildly inaccurate.
One way to get an accurate value of your property is to order a property appraisal. With an appraisal, a certified home appraiser reviews the property and compares it to similar properties that have sold recently. This analysis tells the appraiser how much buyers are currently willing to pay per square foot for similar homes in your area. The appraiser can then apply that price per square foot to your house to determine the market value of your property.
Home inspections can cost around $300-$500, depending on your area and the size of your home. Because of this expense, homeowners often choose to contact local real estate agents, who are willing to offer a similar service, often free of charge. This can be a good option if you’re simply curious about your home equity. But if you need an accurate valuation for the purpose of refinancing your home loan or getting a new loan, you may be required by your lender to have a formal appraisal done.
How to Find the Balance Due on Your Loan(s)
The balance due on your home loan is a much easier figure to find than the market value of your home. Simply check your most recent mortgage statement. The remaining principal balance of your loan should be listed. If, for any reason, you can't find the principal balance remaining, contact your mortgage loan servicer to ask.
You should also check for any other loans or debts against your house. If you have a second mortgage, for example, the balance of that loan should be added to your primary mortgage loan balance to determine the total amount you owe on your home. Similarly, if you have a tax lien or mechanics lien against your property, you should add those balances to your loan amounts as well.
How to Calculate Equity
Now that you know your home’s value and the total balance due on your loan(s), you can calculate your home equity to determine how much equity you have in your home. Subtract the loan balance due from the current market value of your home. The resulting amount is your home equity.
Here is an example:
If the current value of your home is $600,000, and you have a mortgage loan balance of $200,000, your home equity is $400,000 ($600,000 minus $200,000). Now, what if you have a second mortgage with a balance of $40,000 in addition to the $200,000 primary mortgage balance on your $600,000 home? Then your home equity would be $360,000 ($600,000 minus $240,000).
What Is Loan-to-Value Ratio and How Does It Affect Home Equity?
The loan-to-value ratio (LTV) of your home explains how much of your home is currently financed, expressed as a percentage. While home equity looks at the value amount of the property that you own, the LTV looks at how much of your property’s value the bank is entitled to to calculate the LTV, divide the balance due on your loan(s) by the current value of your home.
For example, if you have a mortgage loan balance of $200,000, and the current value of your home is $600,000, your LTV would be 33% ($200,000 divided by $600,000). This means that the bank essentially owns 33% of the value of your property.
Now, if you add a second mortgage loan with a $40,000 balance to the example above, your LTV would be 40% ($240,000 divided by $600,000).
How Does a HELOC or Home Equity Loan Affect Home Equity Value?
HELOCs (home equity lines of credit) and home equity loans are both options that allow you to turn some of your home equity into cash. HELOCs are open lines of credit that you can access and repay as needed. If, for example, you have a $10,000 HELOC, you can borrow up to $10,000 at a time to finance things like unexpected home repairs. Any time you borrow against your line of credit, you would make monthly payments until the balance is repaid (similar to using a credit card).
A home equity loan is a one-time occurrence of borrowing against your home equity. This might be used to finance a major renovation, pay for education, fund a new business or make a down payment on an investment property. Qualifying for a HELOC or a home equity loan requires you to have a certain level of equity in the property. The exact level of equity varies by lender, but most lenders prefer to have owners keep a minimum equity rate of 20% in their home.
If your home is worth $600,000, and your only debt against the property is a mortgage loan of $200,000, your $400,000 in equity equates to 66% of the home’s value ($400,000 divided by $600,000). With such strong equity in the property, you would likely qualify for a HELOC or home equity loan (pending other qualification criteria like income and credit scores).
Taking out a line of credit or loan against your equity would then reduce your equity because the amount of debt against your property would increase. Now, what if your home is worth $600,000, and you have a $500,000 balance on your mortgage? In this case, your home equity is $100,000, which is 16.7% of the total value ($100,000 divided by $600,000). Because this is less than 20%, you might not qualify for a HELOC or home equity loan at this time. You would need to increase your home equity before you could get a HELOC or home equity loan.
How Can I Increase My Home Equity?
There are two levers you can use to increase your home equity:
- Increase the value of your home
- Decrease the debt against your home
How to Increase the Value of Your Home
The value of real estate generally increases over time due organically to appreciation. Appreciation is the natural value growth of real estate due to factors like inflation and buyer demand.
But if you want to manually increase the value of your home, you can do so through value-add projects like renovations. Here are a few ideas for adding value to your current home:
- Renovate the kitchen and bathroom(s).
- Finish the basement to add usable square footage to the house.
- Add an outdoor space like a balcony, patio or deck.
- Upgrade the home’s exterior.
- Add an accessory dwelling unit (ADU) to the property that can serve as an additional housing unit (either to be used as a guest house or to be rented out for passive income).
It’s important to note that renovations don’t always add as much value as they cost. For example, you might invest $30,000 in a kitchen renovation, but the renovation might only increase the property’s value by $25,000. It’s important to consult local industry experts if your goal is to maximize your return on investment.
How to Decrease the Debt Against Your Home
Your other option for increasing home equity is to reduce the amount of debt. You might consider paying off any ancillary loans, like second mortgages or home equity loans. Or you might make an extra payment on your primary mortgage loan.
If you decide to make an extra payment on an existing loan, make sure that your full payment is applied to the principal loan balance. If specific instructions aren’t provided with your payment, your bank could treat the payment as if you’re just making your next payment early and would apply a portion of the payment to the accruing interest.
You can also check to see if prepayment penalties apply before making extra payments on existing loans. Many loans have prepayment penalties to offset the loss of interest income for the lender if the balance is paid off earlier than planned.
Should I Access My Home Equity with a HELOC or Home Equity Loan?
HELOCs and home equity loans allow property owners to tap into their home equity without liquidating their real estate holdings by selling the property. It is important to remember that HELOCs and home equity loans are loans that must be repaid, so the decision to use them should not be made lightly. But there is comfort in knowing that a portion of your equity can be converted to cash when you need money to finance new ventures or cover unexpected expenses.If you decide that a HELOC is right for you, you can apply for a HELOC online quickly, easily and securely with PNC Bank.
The property securing the CHELOC must be located in a state where PNC offers home equity products. PNC does not offer the CHELOC product in Alaska, Hawaii, Louisiana, Mississippi, Nevada and South Dakota.