Your home can provide you with more benefits than just a place to live. If you’ve built equity in your home, you can borrow against it and leverage the money to your advantage.
What Does It Mean When You Have Equity In Your Home?
Equity is the difference between the value of your home and your mortgage principal balance.
Your equity will fluctuate over time as the value of your home and your mortgage principal balance change.
How to calculate home equity
To find the equity of your home, you want to subtract your mortgage balance from your home’s value. You can find your mortgage balance on your statement from your lender, and you can get an estimate of your home’s balance on websites like Zillow.com and Realtor.com. If you want to get a more accurate estimate, you should speak to a realtor or real estate appraiser.
Here’s an example of how to calculate your equity.
Home Equity = (Home value – principal balance)
If your mortgage principal balance is $120,000 and your home value is $180,000, you have $60,000 of equity in your home.
How to find your loan to value ratio
Lenders will want to know your loan to value ratio (LTV ratio or LTV) because it helps to calculate the risk they’re taking by lending money to you.
To determine your loan to value ratio, you want to follow this formula.
LTV = (Amount owed on the loan ÷ Appraised value of your home ) × 100
Based on the previous example of the home equity calculation, you would use the above formula to determine the loan to value ratio.
($120,000 ÷ $180,000) x 100 = 66.7%
Your LTV ratio is 66.7%.
The lower your LTV, the better, because as your LTV falls, the lower the perceived risk to the lender.
There are different standards for what’s considered a “good” LTV, but you typically want to see yours below 80%.
How To Increase The Equity In Your Home
Once you understand the benefits of increasing the equity in your home, you need to know how to do it. Here are four ways to either decrease your mortgage balance or boost your property value.
2 ways to decrease your loan balance
Make a sizeable down payment
Today many loan programs allow you to buy a home for as low as 0% down. Instead of sticking with the lowest possible down payment, you can make a sizable downpayment. This will allow you to start with more equity and a lower LTV.
Pay more than your required mortgage payment
Another option is to pay more than the minimum monthly payment on your mortgage. The quicker you can pay down the balance, the sooner you’ll see an increase in your home’s equity.
Even small additional payments can make a massive difference in your home’s equity since it’ll be going directly to your principal balance instead of toward your interest. Paying more toward your interest will allow you to pay off your home quicker, which can save you tens or hundreds of thousands of dollars.
For example, if you take out a $200,000 mortgage at 4.5% over 30 years with a monthly payment of $1,013 and pay only an extra $100 per month, you’ll pay off your mortgage 5 years sooner and save over $30,000 in interest.
2 ways to increase your home value
Renovate your home
One of the best ways to see an increase in value is to perform renovations known to add to the property value. This can include simple things such as repainting the walls a modern color, replacing the flooring, or updating the kitchens and bathrooms. You can also make updates to the outside of the home by improving the curb appeal with flowers, adding a deck or fence, or painting the shutters.
If you’re renovating with the primary purpose of improving your home’s value, you might want to reach out to a real estate professional who can let you know the changes that will make the most significant impact on your home in terms of value.
Wait for the market to change
Part of your home’s value is simply due to the market. There are ebbs and flows, and you might want to wait until the market is on an upswing to see an increase in the value of your home. Keep in mind that just as your home’s value can improve, it can also decrease.
Benefits Of Building Equity In Your Home
When you have equity in your home, you are sitting on both a financial cushion and a potential source of wealth.
Make home improvements
You can use your home equity to make home improvements that will add to your home’s value. Doing so will be beneficial if you choose to sell your home down the line or borrow against your equity again.
You might benefit from your home equity if you use it to pay off your high-interest debt. Most credit cards, personal loans, and debt consolidation loans will charge interest rates higher than the average home equity loan.
- Here’s a comparison of average rates.
- Home Equity Loan – 5.82%
- Personal loan – 9.41%
- Debt Consolidation Loan – 18.56%
- Credit Card – 19.02%
As you know, interest rates can significantly increase the amount you have to pay back, so consolidating with a home equity loan can save you hundreds and thousands of dollars in interest payments.
You can also use your home equity to make investments that will build wealth over time. These investments might be in business, the stock market, real estate, or something else. The key here is to make well-informed investment and understand the risk that’s present whenever you invest.
The Smart Way To Tap Into The Equity In Your Home
Once you’ve built equity in your home, you might choose to borrow against it to achieve financial gains. One of the most popular options is to take out a home equity loan, which allows you to borrow a lump sum of your home’s equity to use for whatever reason you desire.
There are many benefits to taking out a home equity loan vs. other options such as a home equity line of credit (HELOC) or a cash-out refinance. Learn more about how a home equity loan can help you take advantage of the equity you’ve built in your home.