The ABCs of Home Equity

Smart Solutions • March 2015

Now that the U.S. housing market is on the rebound, it’s a question on many a homeowner’s mind: How much equity do I really have in my home? And more importantly, with spring renovation season just around the corner — how much of it can I borrow? And is this the best way to finance a home improvement or large purchase?

If property values in your neighborhood are on the rise, the market value of your house may be increasing, too. And that means your available equity might also have increased. But, there’s more to determining that figure than the listing price of your — or your neighbor’s — house.

Below, we outline how to estimate your home equity and the amount available to borrow. Plus, we explain the potential tax benefits when “borrowing from yourself.”

What is home equity?

Simply put, equity is the share of your home you actually own versus what you still owe to the bank. For example, if your home is valued at $250,000 and you owe $200,000, then you would have $50,000 in equity.

Homeowners can borrow from their equity in two ways: A home equity line of credit or home equity loan. A line of credit works like a secured credit card with an approved borrowing amount and multiple repayment options. A home equity loan is a one-time lump sum that you borrow and pay back over a set amount of time. From a budgeting standpoint, you make fixed monthly payments on a home equity loan while a line of credit’s payment options are more flexible.

What is a home appraisal — and how does it relate to home equity?

You can get an idea of the market value of your home based on what similar houses are selling for in your neighborhood. But an independent appraised value of your home is not only more accurate, it’s the figure banks will use to calculate your loan options.

A property’s appraised value is influenced by a variety of factors, including recent sales of similar properties, current market trends, number of bedrooms and bathrooms, and square footage. If your appraiser determines your home has gone up in value since your last appraisal, you may have more equity in your home than previously thought.

How much can I borrow?

Banks base their decisions to lend on the loan-to-value ratio, which compares how much a homeowner is borrowing to how much the house is worth. In general, the lower the loan-to-value ratio, the better your chances of getting approved.

To determine the amount available to borrow, many banks use an 80% loan-to-value ratio, as illustrated in the example below.

Home Appraisal: $200,000
$160,000 (80% of Appraised Value) – $120,000 (Balanced Owed) = $40,000
(Total Amount That May Be Available to Borrow)

The actual amount a bank lends you will depend on other factors as well, including your credit history.

Can I deduct the interest?

Unlike auto loans and credit card debt, the interest you pay on a home equity line of credit may be tax-deductible. Taking the deduction depends on several factors, including the date of the loan, the amount of the mortgage, and how you used the proceeds from the line of credit. Check with your tax advisor for complete details.

Interested in learning more?


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