How to calculate home equity
Calculating home equity is pretty simple:
- Take the current value of your home (what it would sell for today).
- Subtract your remaining mortgage balance.
- The result is the amount of equity you have.
Say your home is currently worth $300,000, and you owe $240,000 on your mortgage. You're left with $60,000 in home equity. Home equity can be expressed in percentage form as well. In this case, that $60,000 of $300,000 means you have 20% equity in your home.
What can home equity do for you?
Not only can you use your home equity if you purchase a new home, you can also borrow against the equity you have in your property.
Imagine you're looking to upsize your home, and you have $100,000 worth of equity in your current property. If you sell that home and collect that $100,000 as profit, you could use that money as a down payment on a new home.
You can also use home equity to borrow against your home. You have three options: a home equity loan or a home equity line of credit (HELOC), and a cash-out refinance.
Home equity loans
With a home equity loan, you borrow a lump sum of cash and pay it off over time. The benefit of a home equity loan is that you generally get a lower interest rate than with other types of loans. Plus, you may get approved for a home equity loan even if your credit score isn't great.
The reason? With a home equity loan, your home itself is collateral to secure the loan. A lender who gives you a home equity loan takes on limited risk, because if you fail to make your payments, that lender could eventually force the sale of your home via foreclosure and get the money it's owed.
However, in the case of foreclosure, your home equity loan is generally considered a "second mortgage," meaning that it gets paid off second from the sales proceeds, so a home equity loan is somewhat more risky than a purchase mortgage.
That speaks to the danger of a home equity loan. If you fall behind on your payments, you risk losing your home. But a home equity loan usually comes with a fixed interest rate, so your monthly payments are predictable. That could make them easier to manage.
Many homeowners use home equity loans to improve their properties, but you can use them for any purpose. You can use the proceeds to pay off other debt or cover the cost of education for your children if you so choose.
Home equity lines of credit (HELOCs)
With a HELOC, you don't borrow a lump sum. Rather, you get approved for a line of credit based on your home's equity. You can draw from that line of credit as needed within a preset time frame -- usually five to 10 years. You're only charged interest for whatever part of that line of credit you access.
As is the case with a home equity loan, you can take out a HELOC for any purpose. But in the context of home renovations, a HELOC can be a smart choice. Home improvements can be tricky to budget for. By getting access to a line of credit rather than committing to borrowing a preset sum, you give yourself more flexibility.
Like home equity loans, HELOCs are secured by the properties they're tied to, so if you fall behind on your HELOC payments, you risk losing your home. Also, HELOCs tend to come with variable interest rates, so your monthly HELOC payments could change over time. But HELOCs are also fairly easy to qualify for if you have the equity in your home, and you generally pay less interest on a HELOC than on other types of loan that don't relate to your property.
Cash-out refinances
With a cash-out refinance, you borrow more than your remaining loan balance and get the rest in cash to use as you please. If you owe $200,000 on your mortgage, but your home is worth $300,000 and you want to borrow $20,000 to start a business, you can take out a new mortgage loan for $220,000, which includes the home equity you're cashing out. The first $200,000 pays off your existing loan, and the rest of that cash goes to you.
With current interest rates likely much higher than the rate on your current mortgage, you may experience a bit of sticker shock with a cash-out refinance. Check with several of the best mortgage lenders for the most competitive rates available before committing to a full refinance.