You can benefit from using your home equity in various ways, such as renovating your living space, consolidating debt, or financing a significant expense. However, before exploring your options, it’s essential to determine your current equity amount.
You can do this by calculating the difference between your home’s market value and your remaining mortgage balance. This figure, along with your loan-to-value (LTV) ratio, determines the amount you can borrow through a home equity loan or home equity line of credit, and whether you need to pay private mortgage insurance (PMI).
How much equity do you have in your home?
Home equity is the difference between how much your home is worth and how much you owe on your mortgage. Remember that most mortgage lenders require an appraisal to determine the value of your home to qualify for a refinance or home equity loan.
For example, say that your home is worth $345,000 and you owe $150,000 on your mortgage. Subtract the $150,000 outstanding balance from the $345,000 value. Your calculation would look like this:
- $345,000 – $150,000 = $195,000
In this case, your home equity would be $195,000.
what is the loan-to-value (LTV) ratio?
Once you have the appraised value of your property and the outstanding balance on your mortgage, you can calculate your loan-to-value (LTV) ratio. Loan-to-value is a measure that lenders use to express the ratio of a loan to the value of the property, expressed as a percentage.
Using the above example, you would divide your mortgage balance by your home’s appraised value. You would make the following calculation:
- $150,000 ÷ $345,000 = .43
Convert .43 to a percentage and that gives you an LTV ratio of 43%.
Aim for an LTV of 80% or lower to increase the likelihood of securing a preferred loan option with better rates and avoiding mortgage insurance. Consistently maintaining these numbers could potentially save you thousands of dollars in mortgage payments.
How to access your home equity
Once you’ve calculated your home equity and how much you can borrow, you’ll need to choose between loan types, which include:
- Cash-out refinance: A cash-out refinance is a type of mortgage refinance that replaces your current mortgage with a new, larger loan, allowing you to access your home equity through a first mortgage instead of a second mortgage, like a home equity loan or line of credit. The difference between the amount borrowed and what you owe on the home is given to you in cash and can be used for any purpose, such as home improvement projects, high-interest debt consolidation, or investment purposes.
- Home equity line of credit (HELOC): A home equity line of credit allows homeowners to borrow against their home’s equity in the form of a second mortgage loan. During the draw period, you can continuously borrow money and only pay interest on the amount you borrow. A HELOC is an ideal option for costly, long-term projects like home repairs and renovations.
- Home equity loan (HELOAN): A home equity loan is a second mortgage that allows you to borrow money by leveraging the equity in your home. Unlike a HELOC, you get all the money in one lump sum, making it perfect for large projects and one-time expenses.
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