How To Calculate Home Equity: A Guide

If you make your mortgage payments on time each month, you may wonder, “How much equity do I have in my home?”

Fortunately, you can calculate home equity and decide how best to use it to take advantage of attractive terms and the capital built in the home you purchased.

If you aren’t familiar, home equity is the amount of your home you own free and clear, without financing. Since you financed the home purchase, the bank owns part of the home's value because they have the first lien on your property. If you sold the property, you must repay the lender first and then receive the difference. That difference is your home equity, which you can use for any purpose.

Knowing the formula for home equity and how to calculate it is key to making sound financial decisions with your investment.

To calculate the equity in your home, follow three simple steps: determine the value of your home, figure out how much you still owe on your mortgage loan then subtract the balance you owe on your mortgage from your home's value.

Step 1: Determine The Value Of Your Home

The first step in your home equity calculation is to determine the value of your home. You could use online estimators, like the Rocket Mortgage^® Property Report, but if you want an actual appraised value, consider having an appraisal done to get your home's current value. Most home appraisers charge $600 – $2,000, depending on where you live and the size of your home.

Step 2: Figure Out How Much You Owe

Next, you must know how much you owe on your mortgage loan to calculate your home equity. You can reference your latest mortgage statement, call your mortgage company or log into your online account.

Step 3: Subtract Your Loan Balance From Home Value

The final step is to take the home's market value minus the current mortgage balance to determine your home's equity.

An Example Of Calculating Home Equity

For example, if an appraiser determines your home is worth $400,000 and you find your mortgage balance to be $200,000, you have $200,000 in equity:

 $400,000 - $200,000 = $200,000

Your home equity is yours to use how you want. No rules state how you can or cannot use it. Here are some of the common ways homeowners use their home equity.

• Eliminate private mortgage insurance (PMI): If the appraiser determines your home is worth enough that you have at least 20% equity in it, you can request that the lender cancel your PMI. This means your loan-to-value ratio (LTV) is 80% or less, and you no longer need to pay PMI. This won't give you access to your home equity but will lower your monthly payment, saving you money.
• Make home improvements: If you liquidate some of your home's equity, you can use the funds to pay for home renovations. This is one of the best uses of home equity because you reinvest in the home, increasing its value.
• Pay for tuition: A home equity loan can be used to cover your child’s college tuition or room and board costs beyond any scholarships or financial aid they can receive.
• Consolidate debts: Credit card interest rates are generally much higher than mortgage rates. Using your home equity can help you consolidate your debts into one loan, saving money on interest and paying only one bill each month.
• Start a business: If you need capital to start your dream business, you can borrow the funds from your home equity, paying lower interest rates than you might for a personal or business loan.
• Emergency fund: If you haven't saved 3 – 6 months of expenses, home equity line of credit (HELOC) can provide access to the funds needed in an emergency. You don't have to spend the funds unless necessary, but they are there if you need them. Keep in mind, some lenders, including Rocket Mortgage, do not offer HELOCs.

Most homeowners have three ways to access home equity while staying in the home: cash-out refinance, home equity loan or HELOC.

• Cash-out refinance: This is a new first mortgage that replaces your existing first mortgage with a loan with a higher balance. You then receive the difference to use how you want. Your lender will give you the funds in one lump sum, and you must leave 20% of your home's equity untouched.
• Home equity loan: This second mortgage also provides your funds in one lump sum and allows you to take out up to 90% (combined with the first mortgage) of the home's value. The rates on home equity loans may be lower than most consumer loans because they use your home as collateral.
• Home equity line of credit (HELOC): This is also a second mortgage, but it's a line of credit that you can typically draw on for 5 – 10 years, depending on the lender. You must pay interest on the amount withdrawn during this time but can repay the amount borrowed, too, just like a credit card. After the draw period, you must make principal and interest payments to repay the full amount used.

You may have equity in your home if you've made mortgage payments for a while or your home's value increased. Knowing how to calculate home equity, how to access it and the best ways to use it is important. You aren't obligated to use your home equity. You can let it accumulate or withdraw it with a cash-out refinance, home equity loan or HELOC and make your equity work for you.

If you’re ready to start your journey of building home equity by purchasing a home, start the mortgage approval process today.