Using Your Home Equity
The Balance’s Guide to Using Your Home Equity
Frequently Asked Questions
How do you calculate your home equity?
You can calculate your home equity by subtracting how much you owe on your mortgage from the home’s value. For example, say your home is valued at $400,000 after an appraisal and you owe $250,000 on your mortgage: $400,000-$250,000 is $150,000. To find your loan-to-value ratio (which is important to lenders), divide your loan balance by your home’s appraised value: $250,000/$400,000=0.625 (or 62.5%). The lower the LTV, the more equity you own.
What is equity in a home?
Home equity is simply the portion of your home that you own. Since most of us finance our home purchases with a mortgage, the lender has an interest in the property, too. This is represented by the amount you still own on the loan. Your piece is the difference between what you still owe and what the home is valued at. For a home valued at $300,000 and still owing $200,000, the equity is $100,000 ($300,000-$200,000=$100,000).
What is a home equity line of credit?
A home equity line of credit (HELOC) is a type of home loan in which you borrow with your home’s equity as collateral. A HELOC allows you to borrow up to a certain limit set by your lender, and you only pay interest on the amount you actually borrow, similar to a credit card. In contrast, a home equity loan delivers a lump sum up front, and you pay interest on the entire amount borrowed, similar to a regular mortgage.
How do home equity loans work?
A home equity loan is a type of second mortgage on your home. Your first mortgage is the one you used to buy the property. If you have built up equity in the home, you can add additional loans using your equity as collateral. This is your home’s appraised value minus what you owe on any other loans. The application and approval process is much like the process you followed with your first mortgage. You will provide income and other financial details, and you will pay closing costs.
Right of Rescission
If you’re taking out a home equity loan, home equity line of credit (HELOC), or refinancing your home loan with a different lender, you have three days from when you sign the contract to rescind, or cancel, the deal.
A home equity line of credit (HELOC) allows you to borrow money by using your home's equity as collateral. Your lender sets a borrowing limit, and you can choose to borrow as much of that as you want for an agreed-upon period of time. It’s like a credit card or any other line of credit—you withdraw money as you need it, and you only pay for what you borrow.
Rate and Term Refinance
A rate and term refinance, also known as a traditional refinance, allows you to change your interest rate, your loan length, or both. The refinance creates a new mortgage that pays off your existing mortgage.
A cash-out refinance will happen when you replace an existing home loan by refinancing with a new, larger loan. By borrowing more than you currently owe, the lender provides cash that you can use for anything you want. In most cases, the “cash” comes in the form of a check or wire transfer to your bank account.
PITI is an acronym that stands for "principal, interest, taxes, and insurance." Those four things make up most homeowners’ monthly housing payments.
Annual Percentage Rate (APR)
An annual percentage rate (APR) is the interest rate you pay each year on a loan, credit card, or other line of credit. It’s represented as a percentage of the total balance you have to pay.
A real estate appraisal establishes a property's market value—the likely sales price it would bring if offered in an open and competitive real estate market. Lenders require appraisals when buyers use their homes as security for their mortgages.
Mortgage brokers are professionals who are paid a fee to bring together lenders and borrowers. They usually work with dozens or even hundreds of lenders, not as employees, but as freelance agents.
Closing costs include payments to a variety of people and organizations for services during the homebuying process. Standard closing costs might range from 2%-5% of your loan. But that depends on where you live, the property you’re buying, and other factors.
Home equity is the portion of your property that you truly “own.” Your lender has an interest in the property until you pay off your mortgage, although you’re still considered to be the homeowner.
A debt-to-income ratio is a measurement of your monthly income compared to your debt payments. Lenders often use this ratio to determine your creditworthiness.
A loan-to-value (LTV) ratio compares the amount of a loan you're hoping to borrow against the appraised value of the property you want to buy. Lenders use LTVs to determine how risky a loan is and whether they'll approve or deny it.
A reverse mortgage is a popular option for homeowners age 62 or older who wish to draw equity from their home to supplement their income without making mortgage payments. Reverse mortgages sponsored by the U.S. Department of Housing and Urban Development (HUD), known as Home Equity Conversion Mortgages, can be used for any purpose.