If you’re wondering, “What’s the process for taking equity out of my home,” you’re not alone. As home values have skyrocketed, thousands of homeowners have tapped into their home’s equity to pay off debt, fund a remodel, or pursue other financial goals.
To help bring you up to speed, we’ll be discussing how you can calculate equity, what percentage of equity you can borrow from your house, and how you can increase your total equity. We’ll also explore the basics of a home equity line of credit (HELOC), home equity loans, and cash-out refinance, three of the most common ways to tap into your home’s value.
How to Calculate Home Equity
In order to determine the amount you can borrow, you must first calculate your current home equity. To calculate home equity, you must know two variables: your mortgage balance and your home’s current value.
For instance, let’s say that your mortgage balance is $250,000 and the market value of your home is $400,000. In this scenario, you have approximately $150,000 of equity in your home.
Since you have equity in your home, you would be eligible for a home equity loan or HELOC. However, that doesn’t mean you could use 100% of your home’s $150,000 equity.
Before you can answer the question, “How much equity can I borrow from my house,” you must conduct a loan-to-value calculation.
What Is My Loan-to-Value?
Loan-to-value ratio (LTV) refers to how much your home is worth compared to what you currently owe on your mortgage. Your LTV has a direct impact on the amount you can borrow.
Lenders set limits that dictate the amount of equity you can use to borrow money. Generally, they won’t allow you to exceed 80% LTV when obtaining a cash-out refinance. However, some lenders may allow you to have an LTV of up to 95% on a HELOC or home equity loan.
To keep things simple, let’s use the same figures from the example above. If your home is valued at $400,000 and you owe $250,000 on your mortgage, your loan-to-value is 62.5%.
If you apply for a home equity loan or HELOC, you could borrow up to 17.5% of your home’s total value, which translates to approximately $70,000. That would bring your loan-to-value to exactly 80%. The percentage of loan to value to borrow against varies by lender and loan type.
Some lenders won’t allow you to borrow past this threshold because they want to ensure that the home still has positive equity — if home values drop, the lender would still be able to recoup their money should you default on your loan. This would not be the case if they allowed you to use all of your home’s equity.
How Can I Increase My Home Equity?
Even if you don’t currently plan on applying for a home equity loan or HELOC, you should always be working to increase your home’s equity.
If your home has more equity, you have increased financial flexibility. You could take out a home equity loan to address unexpected financial needs or sell your home for a profit should you decide to relocate or upgrade.
Here’s how to start building equity in your home.
Increase Your Mortgage Payments
You’ll build equity organically as you make payments on your mortgage. However, you can speed up this process by paying more. You don’t have to do anything drastic, like doubling your mortgage payments. Simply allocating $100-200 extra per month toward your mortgage will help you build equity faster.
Paying extra on your mortgage also has other benefits, especially if you intend to stay in the home indefinitely. Increasing your monthly mortgage payments will help you repay your home loan sooner. This, in turn, could save you thousands in interest over the life of the loan.
Add Value to Your Home
Consider upgrading your home to add a lot of equity quickly. There are many ways to upgrade your home. One of the best is to invest in cosmetic upgrades, such as new paint and flooring.
If you want to give your equity a major boost, consider undertaking more involved upgrades, such as remodeling your kitchen or master bathroom. You could also hire a contractor to add on to your home, thereby increasing the square footage and overall value. Investing in outdoor upgrades like a grilling area or pool can build equity, too.
With that being said, upgrades rarely translate to a dollar-for-dollar increase in home equity. You should therefore carefully evaluate the pros and cons of any potential upgrades before investing in them.
Refinance to a Shorter Loan Term
Refinancing to a shorter loan term is another great way to build equity in your house. For instance, you could refinance from a 30-year mortgage to a 15-year mortgage. While this would increase your monthly payments, you would build equity faster and pay off your loan sooner, thereby saving money on interest payments.
Refinancing to a shorter loan term might also help you obtain a lower interest rate, offsetting some of the monthly increase caused by transitioning to a shorter loan term.
How to Tap into Your Home’s Equity
When you’re ready to tap into your home’s equity, you can do so using one of the following financial products.
A home equity line of credit, or HELOC, functions similarly to a credit card in that you can use available funds as needed. HELOCs have a revolving balance, meaning you can pay down your loan or increase the balance by borrowing additional funds.
Let’s say you get approved for a HELOC and plan to use your home’s equity to finance a remodel. Your total available funds amount to $70,000. You don’t have to withdraw this entire sum at once. Instead, you can borrow just what you need up to the 80 LTV threshold.
HELOCs typically have a ten-year borrowing period. You can draw funds at any point during this time, provided you’re still under the borrowing limit.
You only have to make interest payments on your current balance during the draw period. After the ten-year window closes, a 20-year repayment period will begin, at which time you have to start paying principal and interest.
Home Equity Loan
A home equity loan is a second mortgage that allows you to make a one-time draw of funds based on your home’s equity. Your first mortgage stays intact and you will have a new additional payment on the home equity second.
Using the example above, you could withdraw up to $70,000 or obtain a home equity loan for a lower amount as well. However, if you need additional funds in the future, you’d have to apply for another home equity loan.
Home equity loans have fixed interest rates and repayment periods. The interest rate on a home equity loan is somewhat higher than traditional mortgage rates.
Cash-out refinance loans allow you to refinance your current mortgage to obtain a lower interest rate and tap into your home’s equity.
Imagine that you owe $250,000 and want to cash out $50,000. In this scenario, your new mortgage would be $300,000 plus any closing costs. $250,000 would go toward paying off the current mortgage, and the remaining balance would be paid out to you at closing.
Cash-out refinances typically adhere to the 80% LTV limits products. They’re a great option if you want to reduce your interest rate or refinance into different loan terms (i.e., transition from a 30-year to a 15-year mortgage).
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