If you’ve been living in your home for a while, then you’re probably pretty familiar with the ins and outs of having a mortgage—escrow, mortgage insurance, monthly payments, and the like. What you might not know is that as you go through the motions of maintaining your mortgage, you’re also building home equity.
According to Investopedia, the definition of home equity is “the value of the homeowner’s interest in their home.” In other words, home equity is the amount of your home that you actually own. Your home’s value can fluctuate over time depending on the larger real estate market, and the amount of home equity you start with depends on the down payment that you made when you bought your home.
If you’ve built up a substantial amount of equity in your home—either by living there for a while and making a lot of mortgage payments to chip away at your principal balance or because you put a lot of money down when you purchased—you might be able to use some of your home equity to get cash to fund a remodeling project. This is called a cash-out refinance, and it could give you the freedom to make the right renovations, increase your home’s value, and receive more favorable returns when you decide to sell your home down the road.
So what does this all mean, and how can you calculate how much equity you have in your home now? Your first move should be to plug a bunch of numbers into this refinance calculator. Or, do the math yourself by starting with the current market value of your home and subtracting how much you still owe on your mortgage.
Here’s a simple example: If your home is valued at $250,000 and you still owe $150,000, then you have $100,000 in equity. You can also divide your home equity by the market value of your house to determine your home equity percentage, so in this case $100,000 ¸ $250,000 = 0.4, or 40%.
Here’s an example that considers a few more factors: If you are five years in to a 30-year, fixed-rate mortgage on your home that was valued at $200,000 when you bought it, an appraisal puts its current value at $250,000, and you still have $195,000 left to pay of the original loan, you have $55,000 in equity.
$250,000 – $195,000 = $55,000
Your home equity percentage in this scenario would be:
$55,000 ¸ $250,000 = 0.22, or 22%.
Another way to express home equity is through the loan-to-value (LTV) formula, which divides your remaining loan balance by your home’s current market value and is the inverse of your home equity percentage. Using our previous example:
$195,000 ¸ $250,000 = 0.78, or 78% LTV
Keep in mind that many lenders will not allow homeowners to borrow against the full amount of their home equity (it’s usually somewhere around 75 or 90 percent). Lenders also tend to lend less favorably to borrowers with a high LTV, because it might suggest you are overleveraged and have borrowed too much already. Read Mr. Cooper’s Top Cash-Out FAQs to learn more about the factors that go into determining how much equity you can take out.
If you do your research, crunch your numbers, and find out that you are eligible for a cash-out refinance, that’s great! You could use the money for a variety of value-adding home improvements, like installing hardwood flooring or investing in energy-efficient appliances.
A cash‐out refinance increases your mortgage debt and reduces the equity you may have in your home. Your monthly mortgage payments may be higher.