What Is Home Equity?
Home equity is the difference between how much you owe on your mortgage and how much your home is worth. You can build equity as you pay down your loan balance and as the market value of your home increases.
Here’s an example of how you build equity in a home:
- You make a $20,000 down payment and take out a $180,000 mortgage loan to purchase a home with a sales price of $200,000.
- After five years, your monthly loan payments have reduced your mortgage balance down to $167,000.
- During this same time, your home’s market value has increased to $230,000.
- To calculate your home’s equity, subtract your mortgage balance of $167,000 from the current market value of $230,000.
- You have $63,000 in equity.
You may or may not be able to borrow your full amount of equity. Most lenders use Loan-to-Value (LTV), Combined Loan-to-Value (CLTV), and Debt-to-Income (DTI) ratios, along with other factors when determining your interest rate and how much you're eligible to borrow.
Common Uses of Home Equity Loans
- Debt consolidation
- Home improvements and repairs
- College tuition
- Weddings or other life events
- Medical expenses
- Unexpected expenses and emergencies
Home Equity Terms to Know
Debt-to-Income Ratio (DTI): The percentage of your monthly income that currently goes to repaying other debts. To calculate this ratio, total up your monthly bills (excluding utilities) and divide by your total gross monthly income. The result is your DTI. For example, if your monthly debts total $2,000 and your gross monthly income is $7,500, your DTI is 26%.
Loan-to-Value Ratio (LTV): Loan-to-value ratio is a term used by lenders to represent the amount of a loan compared to the value of the property securing the loan. For example, if a borrower takes a $75,000 loan to buy a $100,000 property, the LTV would be expressed as $75,000 to $100,000, $75,000/$100,000 or 75%.
Combined Loan-to-Value Ratio (CLTV): Combined loan-to-value ratio is similar to a loan-to-value ratio (LTV), but implies that more than one loan has been secured by the property. The CLTV includes the total amount from all loans borrowed divided by the total value of the property. For example, if a property owner takes out two separate $20,000 loans on a property worth $100,000, the CLTV would be calculated as $20,000 + $20,000/$100,000 or more simply, $40,000/$100,000 or 40%.
Prime Rate: Generally the lowest interest rate at which money can be commercially borrowed, based in part on the federal funds rate set by the Federal Reserve. View the current U.S. Prime Rate.
Draw Period: A draw period is the time during which you can borrow money from a line of credit.
Repayment Period: Amount of time in which you have to pay off your loan. During this period, you can no longer borrow funds from your line of credit.