For many homeowners, owning a house not only offers a place to live but also serves as the family’s most important asset. A home’s equity represents a powerful tool that homeowners may leverage to help pay down debt, build wealth, cover emergency expenses, and pass on to the next generation.
To calculate your home equity, you’ll need to know a few numbers and perform some basic calculations, but all it takes is your most recent mortgage statement and the current or appraised value of your home. Even if you don’t have firm numbers, you can still roughly calculate home equity and keep an eye on your growing portfolio.
What is home equity?
Home equity is the percentage or dollar amount that comes from taking a home’s current worth and subtracting the remaining balance owed on the mortgage. A home worth $300,000 with an outstanding mortgage amount of $200,000 would equal $100,000 equity in the house.
Home equity can increase each month as the homeowner makes payments on the mortgage. Equity will also increase as the value of the home increases. Equity may fall when market conditions cause the home’s value to fall at a rate faster than the homeowner can pay down the mortgage.
How is home equity different than home value?
To calculate your home equity, you’ll need to know your home’s value, which is the amount of money a buyer will pay for a house. Market conditions significantly influence home value. A strong market may increase home value, and a weak market may reduce home value. As mentioned home equity is your home’s market value minus any remaining home mortgage or debt on the property.
Sometimes, home prices will sink to a level that places the homeowner “underwater” on their mortgage, which means their current loan balance on their mortgage is higher than the value of the home. This is called negative equity, and it may persist until the homeowner makes additional payments to reduce their debt to income ratio and the economy improves enough to stop falling home prices. This is why so many homeowners are obsessed with building equity in their home… so they can ensure their net worth grows and their home stays “above water”.
Home value is a significant number because it’s necessary for figuring out the equity a homeowner has in their home. With that number, a homeowner may determine whether they can borrow money, take out additional financing, sell their home for a profit, or have enough down payment to buy another home.
How to calculate my home equity percentage?
To calculate the home equity percentage, divide the current mortgage balance by the home’s current market value. For example, a homeowner gets an on-site appraisal and determines her house is worth $500,000. She also has a balance of $200,000 remaining on the mortgage.
$200,000 divided by $500,000 is 0.4, or 40 percent. This means the homeowner has a remaining loan balance of 40 percent in this case and a home equity percentage of 60 percent. The home equity percentage a homeowner has may influence the decision to sell the home, refinance, or get a home equity loan.
Home equity calculators
Many online banking websites offer calculators to help homeowners figure out their current home equity. Bankrate has an entire page devoted to different loan and payoff calculators and provides a relatively straightforward home equity calculator page.
However, a simple calculator will also get the job done, as long as the homeowner knows their home value and the amount owed on the mortgage. A quick look at a monthly statement is a good place to start, and an online home price estimator can also help when an actual appraisal from a real estate professional or appraiser isn’t available. Then, it’s simply a matter of performing the calculations to determine the home’s LTV ratio or the homeowner’s equity in the home.
How to cancel private mortgage insurance
Private mortgage insurance, commonly abbreviated as PMI, is insurance required for some homeowners who have conventional loans. Lenders require PMI because it protects their investment, unlike homeowners’ insurance, which is for the homeowner and fixes the home in the event of damage. Generally, 80 percent is the maximum LTV ratio required by a lender before they require PMI.
Most homeowners will pay for their PMI as a monthly premium with an added amount on the mortgage payment. In some cases, PMI may help a buyer qualify for a home loan because they don’t have 20 percent of the money upfront for their down payment; however, it will also increase the overall cost of the loan.
According to the Consumer Protection Finance Board, reaching a certain level of equity in the home may allow the homeowner to cancel their private mortgage insurance. Homeowners may request cancellation of their PMI when the loan’s principal balance falls below 80 percent of the home’s initial value.
Disclosures from any equal housing lender should include the date on which the lender no longer requires the borrower to pay private mortgage insurance. However, making early or extra payments may allow a homeowner to cancel their PMI in advance of that specified date.
Homeowners must meet the following conditions to qualify for PMI cancellation.
- Requests for cancellation must occur in writing to the lender directly
- The borrower must have a good payment history on the mortgage loan
- The loan’s status must be current
Some lenders may require that borrowers have no second mortgages (sometimes known as junior liens) on the home. Lenders may also need a new appraisal of the house to confirm that the home’s appraised value hasn’t declined below the home’s original value when it sold.
How much equity do I have in my home after 3 years?
To determine how much equity you will have in your home after three years, you need to know your total loan amount, your monthly interest rate, and your loan period (time length). With those three numbers in mind, you can plug them into an amortization table and see how much home equity you’ve built up.
At the very start of mortgage payments, the bulk of the monthly or biweekly payment goes to pay the interest on the loan, and only a small portion goes toward paying down the principal or the initial loan amount. The ability to build equity in the home is minimal for the first few years of the loan term.
Over the first few years of mortgage payments, the total loan balance doesn’t decrease by a substantial amount, which means the equity gained in the first three years often isn’t enough to consider selling the house for a profit, refinancing the loan, or taking out a HELOC or home equity loan.
In rare cases, hot market conditions may quickly increase the amount of equity a homeowner has in their home due to a rapid increase in home value. Still, there’s no guarantee a home will increase in value enough over just three years to make financial decisions like selling the home a good idea.
Take a homeowner who purchases a home for $200,000 with a 30-year mortgage and an interest rate of 5 percent. Based on the amortization table for the loan, the borrower will owe $190,127.80 at the end of three years. By dividing the current mortgage balance ($190,127.89) by the initial purchase price ($200,000), it turns out that the homeowner has just approximately 5 percent in equity.
How much equity will I have in 5 years?
Using the same example as before: a $200,000 mortgage with a 30-year loan and 5 percent interest, the loan balance at the end of five years would be $183,349.06. The homeowner would have just over 9 percent equity in their home at the end of 5 years of monthly payments.
However, bear in mind that five to seven years is often enough time for the home’s value to appreciate enough that selling, refinancing, and home equity loans start to make sense. For example, imagine the house that sold for $200,000 increased in value to $220,000 over five years.
With an appraised value of $220,000 and a loan balance of $183,349.06, the homeowner would actually have closer to 17 percent for their loan to value ratio.
How to tap into your home equity
Homeowners may choose a home equity loan, cash-out refinance, or home equity line of credit (HELOC) to utilize home equity. Using your home’s value is an excellent way to finance home improvement projects and pay off other loans and credit cards with higher interest rates.
For example, a credit card with a 20 percent rate will cost much more in the long run than a HELOC with a 5 percent rate. One of the added values of conducting home improvements is that the process helps increase the home value, which, in turn, increases the home equity and property value.
A home equity loan is also known as a second mortgage, and it’s a fixed amount that the homeowner pays over a set period. Like a traditional mortgage, home equity loans are amortized, which means the homeowner pays more interest than the principal at the start of payments.
Home equity loans usually have a modestly higher interest rate than the primary loan. The loan represents an additional financial risk to the lender should the homeowner default on their payments. The is an initial draw period for a home equity loan, after which the homeowner cannot borrow more money.
Meanwhile, a home equity line of credit or HELOC is a more flexible option that is also considered a second mortgage but offers the chance to borrow repeatedly from the equity in your home. Home equity lines are popular options for paying off credit cards with high variable interest rates.
A benefit of using a HELOC is that it doesn’t require payment of closing costs like a second mortgage, which can reduce the overall cost of the line of credit. However, a HELOC may have an adjustable rate, which means the rate may increase over time. Some lenders do offer HELOCs with a fixed interest rate option.
The final option to tap home equity is the cash-out refinance or cash-out refi, which homeowners use when they want the cash from their home and are willing to take on a larger mortgage for it. A cash-out refinance replaces the original mortgage loan with a new loan, with the homeowner receiving the money rather than getting a line of credit out of it.