What is equity?
In general, equity is the value of any asset minus the liabilities against that asset. In the case of home equity, that asset is your home. Home equity is determined by subtracting the total amount of liabilities on your home from its fair market value.
First, determine how much your home is worth
Determining home equity might seem like an easy equation, but to do it effectively you need to know the current fair market value of your home. There are a lot of ways to do that, each with varying degrees of accuracy.
Online estimators can give you an estimate of your home’s value based on your address, but these are just that: an estimate. For a better view of your home’s value, ask a lender for an appraisal.
In a desk appraisal a lender will analyze your home and location’s data and give you an amount based on that. A full appraisal goes even further. In that, the lender comes to your home, makes a thorough examination of the property, and then generates an estimate.
A full appraisal can generally give you a better sense of your home’s true worth if you’ve made recent improvements such as adding a deck or doing any kind of remodeling.
Now for some simple math
Let’s say Alice and Bob have a nice house that’s worth $400,000. Their mortgage balance is $230,000.
The amount remaining on their mortgage is the liability against the value of their home. The value of their home minus the liability is $170,000. That’s Alice and Bob’s approximate home equity dollar amount. That’s a pretty straightforward example, and it sums up the basics of how home equity is determined.
But the values of homes can change. If Alice and Bob are in a nice, up-and-coming neighborhood, their home’s value might go up considerably. Let’s say their home jumps up to $500,000. They still only owe $230,000, but their home’s value minus liability is now $270,000. Alice and Bob’s net worth just increased considerably due to rising home values.
It’s not uncommon for homes to have more than one loan associated with them. When that happens, the total amount of the loans is measured against the home’s value. That amount is known as the loan-to-value ratio, or LTV.
Let’s say Alice and Bob have a home equity line of credit of $40,000. That would bring their total liabilities against their home up to $270,000. We can divide their liabilities, $270,000 by the value of their home, $500,000. We get 0.54 or 54 percent. That number shows how leveraged Alice and Bob are regarding their home, and can provide a lender with context for any future loans or investments that our hypothetical homeowners might make.
What can home equity do for you?
Home equity is a major asset, one that homeowners can use to their advantage. It can be used to buy a new home, or serve as an asset that homeowners can borrow against. You can spend against home equity with what’s known as a reverse mortgage, or use it as a major boost to your credit rating. Whatever use you put it to, home equity is a pillar of financial security and independence.
We hope these tips bring you closer to purchasing the home of your dreams! If you’re ready to own a home and begin gaining equity, contact us, and we’ll get you started. You can also follow our community on Twitter or Facebook.