Home equity is the difference between the current value of your home and the amount you still owe on your mortgage. It is an important part of your overall finances, affecting whether you need to pay private mortgage insurance or can access cash to cover expenses such as renovations, emergencies or debt consolidation. Knowing the amount of your equity, how to increase it and smart ways to put it to use can improve your financial life.

You can determine your home equity with a simple subtraction equation. Start with the current value of your home. You can get that through a professional home appraisal or use free online resources like the Bank of America Home Value Tool to get an estimate. Next, determine the amount you owe on all loans secured by your house. This includes your mortgage plus any home equity loans or home equity lines of credit. Then subtract what you owe from your home’s value to get your equity. Here’s how it works for someone whose home is worth $450,000, with a mortgage balance of $250,000, and who has no other loans secured by the house.

Your home equity can give you access to money at lower interest rates than credit cards or personal loans. Home improvements are among the most common uses for home equity financing. Some projects, such as upgrading the kitchen or bathrooms, could increase the value of your home. In certain cases, interest on home equity loans used for renovations is tax deductible. Consult your tax adviser to be sure. Other uses include tuition, starting a business, unexpected expenses and debt consolidation.

It’s important to remember that home equity financing increases your overall debt and uses your home as collateral. If you default on payments, you could lose your home. That’s why expensive discretionary purchases, such as vacations or an extravagant wedding, are generally not good reasons to draw on your home equity. Before tapping your home equity, make sure you also evaluate other options. For example, would student loans be a better way to cover tuition? Or could you set up interest-free payment plans to cover medical bills?

There are several ways to convert your equity into cash. The amount of equity needed to qualify for home equity financing varies by lenders, but most require you to have at least 20% equity in the value of your home. In addition to equity, lenders will review your credit history, credit score and total debt to determine if you’re qualified.

• Home equity line of credit or HELOC
  This is a revolving line of credit based on your home’s equity. You can use it as needed throughout a borrowing or draw period, which is typically 10 years. During that time, you must make minimum monthly payments. At the end of the draw period, you’ll have a set amount of time—usually 20 years—to pay off any remaining balance. The interest rate varies during the life of the credit line depending on economic conditions.
• Home equity loan
  This is a loan for a fixed amount of money—typically no more than 80% of your equity. You receive the money in a single lump sum and pay off the loan in equal monthly payments over a fixed term, which can be as long as 30 years. The interest rate is fixed.
• Cash-out refinance
  This is a new mortgage that takes your equity into account. The interest rate, length of the loan and payment schedule are all new. The money from the new loan pays what’s left on your existing mortgage and closing costs. You get the rest in a lump sum.

Here are typical features of each type of loan. Details may vary depending on your situation, so you should check with your lender for specifics.

Loan-to-value ratio (LTV) is a measure many lenders use to make a decision about loans and financing. When you first apply for a mortgage, this equation compares the amount of the loan you’re seeking to the home’s value. If you currently have a mortgage, LTV is based on your loan balance. To avoid private mortgage insurance (PMI) or be eligible for a cash-out refinance, your LTV typically needs to be 80% or less.

To determine your LTV, divide your loan balance—you can find this number on your monthly statement or online account—by your home’s current value. Multiply that number by 100 to convert it to a percentage.

In our example, it looks like this:

The math changes if you also have or are seeking home equity financing. The new calculation is called combined loan-to-value ratio (CLTV). It compares the value of your home to the combined total of the loans secured by it, including the loan or line of credit you’re seeking. Most lenders require your CLTV to be less than 85 percent to qualify for home equity financing, though the cutoff can vary.

Let’s say the person in our example is seeking a $100,000 HELOC.

Here’s how their CLTV would be calculated:

You can build equity—and lower your LTV—by paying down your loan’s principal. This happens simply by making your monthly payments. To increase equity faster, consider paying more than your required mortgage payment each month. But first check to make sure your loan doesn’t carry any prepayment penalties.

Your equity can also increase through appreciation. While property values fluctuate in individual markets, they increase an average of 3 percent a year nationally, according to Freddie Mac . In addition, you may be able to boost the value of your home by making improvements. Keep in mind that economic conditions can affect your home’s value no matter what you do. If home prices increase, your home equity could increase, while falling home prices could cancel out the value of any improvements you might make.