How to calculate your home equity

Understanding your home equity—and how to calculate it—is important to homeowners. Building equity can help improve your finances; it affects everything from whether you need to pay private mortgage insurance to what financing options may be available to you.

You can figure out how much equity you have in your home by subtracting the amount you owe on all loans secured by your house from its appraised value. In a typical example, homeowner Caroline owes $140,000 on a mortgage for her home, which was recently appraised at $400,000.

Lenders may use other calculations related to equity when making decisions about loans. One common measure they use is the loan-to-value ratio (LTV). 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, your LTV is based on your loan balance. LTV can affect whether you pay private mortgage insurance or if you might qualify to refinance.

To figure out your LTV, divide your current loan balance—you can find this number on your monthly statement or online account—by your home’s appraised value. Multiply by 100 to convert this number to a percentage. Caroline’s loan-to-value ratio is 35 percent.

Tip: A professional appraisal is an essential part of determining your loan-to-value ratio. If an on-site appraisal is needed, your lender will arrange for a qualified appraiser to come to your home and assess its value.

If you pay private mortgage insurance (PMI) on your original mortgage, keep track of your loan-to-value ratio. The Homeowners Protection Act requires lenders to cancel PMI when a home’s LTV is 78 percent or lower (provided certain requirements are met). This cancellation is often preplanned for when your loan balance reaches 78 percent of your home’s original appraised value. However, if your LTV drops below 80 percent ahead of schedule due to extra payments you made, you have the right to request your lender cancel your PMI.

If you are considering a home equity loan or line of credit, another important calculation is your combined loan-to-value ratio. Your CLTV 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. Say Caroline wants to apply for a $75,000 home equity line of credit. She calculates what her CLTV would be if she were approved for it:

Most lenders require your CLTV to be below 85 percent to qualify for a home equity line of credit, so Caroline would likely be eligible.

If your home’s value remains stable, you can build equity (lower your loan-to-value ratio) by paying down your loan’s principal. If your payments are amortized (that is, based on a schedule by which you’d repay your loan in full by the end of its term), this happens simply by making your monthly payments.

If you hope to lower your LTV more quickly, consider paying more than your required payment each month. This helps you chip away at your loan balance. (Check to make sure your loan doesn’t carry any prepayment penalties.)

Also, protect the value of your home by keeping it neat and well-maintained. Smart home improvements can help, too. However, it’s a good idea to consult an appraiser or real estate professional before investing in any renovations you hope will increase your home’s value. Remember that economic conditions can affect your home’s value no matter what you do. If home prices increase, your LTV could drop, while falling home prices could cancel out the value of any improvements you might make.