Calculating your home equity is thankfully simple math (don’t worry!). In this article, I will show you exactly how I calculated the equity in my home and I’ll make it as easy as possible for you to do the same. To answer the question – How much equity do I have in my house? – you need to know two basic variables:
- Your home’s worth or value (as determined by a professional home appraisal or you can estimate it using an online tool)
- The outstanding mortgage principal (as provided to you by your lender or bank)
Without using a specialized mortgage calculator or home equity loan calculator, you can easily find how much home equity is present in your home and if there is enough equity to secure a mortgage refinancing.
How to calculate the equity in my home
Home equity is simply the difference that exists between the current value of your home and your loan’s principal mortgage balance. In mathematical terms, this means that you subtract the outstanding mortgage balance from the estimated value of the home to reveal current equity in your home. The equation is:
Estimated Equity in My Home = Home Market Value – Outstanding Mortgage Balance
- Example #1 – $400,000 – $200,000 = $200,000 in home equity
- Example #2 – $400,000 – $280,000 = $120,000 in home equity
Usually, if your home equity is less than 80% of your home value, then you will be required to pay private mortgage insurance (PMI). This is not a lifelong commitment and there are legitimate ways to drop a required PMI payment without having to refinance. Federal law offers guidance as to when and how to remove private mortgage insurance from your monthly payments.
Calculating the Loan to Value Ratio overcome
Once you’ve calculated your home equity, you can now also determine your home’s loan-to-value (LTV) ratio. The LTV ratio is an important metric because it helps calculate PMI as well as determine a borrower’s eligibility to borrow money more money with a home refinance. The LTV is calculated as follows –
Outstanding Mortgage Balance / Home’s Appraised Value = Home’s LTV Ratio
- Example #1 – $200,000 / $400,000 = .5 or 50% LTV Ratio
- Example #2 – $280,000 / $400,000 = .7 or 70% LTV Ratio
Said another way, to calculate LTV you take your mortgage balance (ie, any outstanding mortgage principal) and divide by your home’s appraisal value.
How much equity do I have and why it matters?
Historically, home equity tends to make up a large portion of many individuals’ household wealth and retirement assets.
Learning how equity builds over time helps create a more secure financial future. Home equity fluctuates in response to changes in the value of the home. In the 3rd quarter of 2021, the average American homeowner’s equity increased by nearly $57,000 when compared to the previous twelve months.
In this image below, CoreLogic shows the average equity gain for homeowners for each state in 2021:
Source – CoreLogic
Remember, home equity is often an important financial concept. As potential collateral, home equity offers affordable and competitive borrowing options that can be used to create a home improvement, consolidate debt, or a child’s post-secondary education, among other financial needs.
How to increase the equity in my home
Home equity can typically be created in two ways –
- Pay Down Your Mortgage – reducing your current loan balance is a great way to increase the total equity of your property. You can make pre-payments or additional contributions to your mortgage each month. Keep in mind that the first few years of mortgage payments primarily cover the interest due. With each mortgage payment, the amount of interest due slowly decreases as the outstanding loan balance begins to fall.
- Increase Your Home’s Worth – a home’s value typically appreciates over time, normally pressured by market and other economic conditions. Real estate prices do fall, but typically not often, and not without other integral economic events/data. The 2008 mortgage recession exemplifies how home prices can fall, even if it is only temporarily. Even with that said, you can make improvements to your home, like adding an additional room or even an ADU, that could significantly increase the value of your home.
Consider contributing an extra amount to the required monthly payment if you want to build equity faster than standard amortization allows. This will begin to reduce the principal at a faster clip. Just make certain there are no prepayment penalties associated with your mortgage.
You can also protect your home’s value by keeping it well-maintained, while improving it may increase its value and, thus, your home equity. It is prudent to discuss potential improvements with a real estate professional who can help you estimate how the improvement may impact the home’s value.
How to pull equity from my home
Home equity is a valuable financial resource that homeowners can use for a variety of needs. Technically, the equity available can be used for any reason; however, most homeowners use their home equity for substantial purchases and large expenses, like debt consolidation, home renovations, or funding their child’s education.
A HELOC – A Home Equity Line of Credit
A HELOC is a type of second mortgage and is a line of reusable credit that is available for a specific access period. A HELOC loan is typically a junior position loan to the first or primary mortgage. The benefits of Home Equity lines are that the interest due is only calculated on the outstanding balance, and the interest is potentially tax-deductible. Interest rates for this type of loan are usually adjustable and vary with the market.
A home equity loan
A home equity loan is another type of second mortgage typically provided as a lump-sum, fixed-rate loan. A home equity loan is available repayment terms that may range from five to 30-year payouts.
A cash-out refinance
Another way to access home equity is to mortgage refinance the existing first lien to a higher loan amount. This is typically the smartest financial move when your interest rate on the current mortgage is above current interest rates. If the rate is reduced significantly by the refinance, the additional funds (added to the original mortgage balance) may have a zero net cost.
A reverse mortgage
The equity present in your home can be used to secure a reverse mortgage, which is available to homeowners 62+ years old. A reverse mortgage is designed for seniors on a fixed income and requires no repayment until the death of the homeowner(s) or the property is sold.
Pull out equity for a down payment on a new house
Many families begin with starter homes and plan to upgrade when their financial outlook is more secure. The equity that builds during these years can be used for a down payment on a new home.
The advantages of tapping home equity
Here are just a handful of advantages of tapping into your home equity:
- Loans secured by real property and, therefore, offers a low, competitive mortgage interest rate.
- The funds can be used for most lawful purposes.
- The total interest paid may be tax-deductible.
The drawbacks of using home equity
- The potential loss of your home if you default on the loan’s monthly payment obligations.
- Typically, closing costs are required to secure a home equity loan or lien.
- It backtracks on the objective of debt-free homeownership.
- Equity may be unavailable if the borrower’s income and credit do not meet lending criteria.
A word about negative equity
If your home appraises at a value lower than your current mortgage balance, you will have negative equity, or as it is sometimes referred to as an underwater mortgage. Here are two examples of negative equity –
Home Market Value – Outstanding Mortgage Balance = Current Estimated Equity
- Example #1 – $150,000 – $200,000 = -$50,000 in negative home equity
- Example #2 – $400,000 – $480,000 = -$80,000 in negative home equity
This was quite prevalent in 2007-2008 when the market was rocked by the mortgage crisis and characterized by falling home prices. But fortunately, the number of homes with negative equity fell nearly 29% in 2020 from the previous year’s total of 1.6 million homes which was representative of three percent of all properties mortgaged!
How much equity do I have in my home after 5 years?
To determine how much equity you will have built up in your home in 5 years will require you to do advanced calculations because there are many factors and inputs that affect your house equity. That said, there is a rule of thumb in real estate called “The Five Year” rule, which states that you only want to buy your home (vs. rent) if you plan to stay five years or more. The reason is because with most mortgage payments, the interest payments are frontloaded (meaning a significant majority of your mortgage payment will go towards interest and not to pay down principal). This means you won’t really start building much equity until after the 5th year of continuous and uninterrupted mortgage payments.
Furthermore, the reason the exact calculation is hard is that we would need to determine the value of your home and the balance of your existing mortgage for each year you want to know your equity. Let’s clarify how home equity may rise or fall, depending on specific scenarios and economic conditions through a simple example: When you bought your $400,000 home, you took out a $300,000 mortgage. Five years later, its value is $500,000, and the mortgage is now $295,000. That means you have $205,000 in home equity ($500,000 – $295,000).
Now you know how to calculate your home equity
Equity in your home is the portion of the value that a homeowner can claim as their own. Building home equity is the primary reason to own rather than rent – because rental payments help create wealth for someone else.
For the most part, the equity built in a home is likely to become your most significant asset and a great way to create future wealth for homeowners.