It is typically presumed that most people know about their home equity; however, many people still do not understand this subject. As a homeowner, you need to learn how home equity works. This is especially true when you intend to refinance a mortgage or borrow money against your property.
How Much Property Ownership Do You Have?
Your home equity worth is the difference between the current market value of your residence as well as the overall amount of debts (mainly, your primary house loan) registered against it.
The credit offered through real estate equity loans depends on the value of your property. Suppose your home is worth $250,000, and you owe a mortgage of $150,000. Subtract the remaining mortgage from the home appraisal value; you will have home equity of $100,000.
How Big a Home Equity Loan Can You Get?
Few lenders will allow you to borrow against the total amount of the home’s appraised value. They typically provide a maximum of 80% to 90% against the available assets, depending on your lender, income, and credit.
Therefore, if you have home equity of $100,000, as shown in the example above, you can get a property credit (HELOC) of $80,000 and $90,000. Race, nationality, and other non-economic factors wouldn’t be considered when determining home equity value.
This is the second example that considers some other factors. Suppose you are five years right into a 30-year home mortgage on your residence. Then a current appraisal or assessment placed the market value of your residence at $250,000. You still have an amount of $195,000 left on the initial $200,000 mortgage. Remember that all the initial home mortgage deposits will be used to repay interests.
You have home equity of $55,000 unless you have other property-related obligations. It is the current market value of $250,000 minus $195,000 in debt. You can also calculate the percentage of your house’s appraised value by dividing your home equity by its market value. In this case, your equity percentage is 22% (55,000 USD ÷ 250,000 USD = 0.22).
For example, consider you get a $40,000 home loan in addition to your home mortgage. The total bankruptcy on the home is $235,000 as opposed to $195,000. It changes the total equity to just $15,000, dropping your residence equity percentage to 6%.
Transaction Costs
Real estate equity is among the most illiquid assets, so using your equity usually incurs costs. When you sell a house, your total transaction cost in the United States is typically between 2% and 5%. Homebuyers pay many of these costs, but remember that they can use these costs as an excuse to negotiate a lower selling price.
You may need to pay mortgage origination fees when you apply for a mortgage loan. Generally, interest rates and the home equity line of credit (HELOC) on the second mortgage are higher than the original mortgage. So, after including these transaction costs, the amount of house equity you use is lower than the total estimated amount.
The Loan-to-Value Ratio
Another way to express home equity is through the loan-to-value (LTV) ratio. It is calculated by dividing the remaining mortgage balance by the current market value. In the second example outlined above, your LTV is 78%. However, this ratio increases to 94% if you have a home equity mortgage of $40,000.
Lenders do not like high LTV because it suggests that you may have too much leverage and might be unable to repay the loan. In times of economic turmoil, they can tighten lending standards, e.g. the financial crisis that occurred in 2020. Especially for the home equity line of credit (HELOC), the bank has increased its credit rating requirement from 600 to 700. They also reduced the dollar amount and the percentage of the property that they were willing to lend.
Both LTV and homeownership are affected by fluctuations in the housing market value. During the 2007-08 subprime mortgage crisis, millions of dollars in home equity allegedly backed by mortgage loans were liquidated. Prices don’t always go up; however, the long-term impact of 2020 on real estate ownership remains uncertain.
