Home equity is one of the biggest perks of homeownership. Home equity is your path out of monthly mortgage payments, and you can tap into home equity as an extra funding source. Lenders have a few restrictions in place to prevent homeowners from borrowing too much equity and putting themselves in financially dangerous positions. Knowing what goes into home equity will help you determine how much you can borrow.
How is Equity Applied to Your Home?
Homeowners build equity in their homes due to a combination of factors. You immediately build home equity with the down payment you used to buy your property. A higher down payment can reduce your monthly mortgage payments and lower interest rates. You also build equity with every monthly mortgage payment. Some homeowners make additional payments to chip away at their principal at a faster pace.
Home equity also accumulates when your home appreciates. A higher property value strengthens your equity position. Over 5-10 years, appreciation can add thousands of dollars to your home equity. In addition, any repairs or upgrades can provide a quick boost to your home equity.
What Determines How Much Equity You Can Borrow from Your Home?
Lenders will look at your property’s market value and mortgage balance to determine your home equity. Banks set maximum LTV ratios as a ceiling for how much you can borrow. Most financial institutions have an 80% loan-to-value ratio cap for home equity financing products. Under this common structure, your current mortgage balance and home equity loan cannot exceed 80% of the home’s value. Some financing products and lenders let you borrow up to 90% of your home’s equity, making this process require a case-by-case approach.
Lenders will also assess your financials before letting you borrow money. Although a home equity loan has collateral, lenders treat it like any other loan. A bank will check your credit score, debt-to-income ratio, and other details before deciding how much you can borrow. Homeowners who barely make the cut with their credit scores could end up with higher interest rates.
Factors That Affect How Much You Can Borrow
Several factors impact how much home equity you can borrow from your home equity. While most banks limit you to an 80% LTV, some banks have higher limits while others have lower limits. Keep these components in mind when estimating how much you will receive.
Your Credit Score
A higher credit score will give you access to more of your home equity and lower interest rates. Lenders look at your credit score when assessing risk. Consumers build up high credit scores by paying debt on time, while consumers with low credit scores often fall behind on payments. Raising your credit score can help you save money on home equity products, personal loans, insurance policies, utilities, and other resources.
Your Debt-to-Income Ratio
Lenders want to ensure that you can make your home equity and mortgage payments on time. Your debt-to-income ratio allows lenders to assess the percentage of your income that goes toward debt payments. A lower DTI ratio will allow you to tap into more of your home equity.
Mortgage Payment History
A home equity loan or a line of credit represents another expense. Mortgage lenders will be rightfully skeptical to give a home equity loan to someone who has fallen behind on their mortgage payments recently. Making on-time mortgage payments and paying ahead of schedule can improve your chances of getting the amount of home equity that you need.
How to Calculate Your Home Equity and Estimate How Much You Can Borrow
Home equity is the difference between your property’s value and the balance on your mortgage. If your property is worth $1 million and you have a $700,000 mortgage balance, then you have $300,000 in home equity.
Even though your home equity position is $300,000 in this example, lenders will not let you borrow the entire $300,0000. Lenders use the loan-to-value ratio to gauge how much you can borrow from your home equity. Most lenders will not give you money if your LTV ratio is 80% or higher. A lower loan-to-value ratio gives you more flexibility, but a high mortgage balance can still restrict how much you can borrow.
For a $1 million home, you cannot borrow more than $800,000 between your mortgage balance and a home equity loan or a line of credit. If you have a $700,000 mortgage on a $1 million home, you can only borrow an additional $100,000 out of your home equity.
Each monthly mortgage payment and any appreciation will increase your home equity. If you wait a year, you can take out more equity between the monthly mortgage payments and home appreciation.
How Much Home Equity Can You Typically Borrow Per Loan Type?
Each financing product has different nuances and requirements. Understanding the differences and how much you can borrow will help you submit the right application. In addition, narrowing your search can help you obtain the right loan and save money on application fees.
HELOC
A home equity line of credit lets you borrow against your home when you need the money. Once you get approved for this 5 to 20-year credit line, you can borrow at will, as long as you don’t max out. Homeowners can borrow up to 90% of their home equity with this financing option. Some lenders will set this cap at 80%, but finding other options is possible.
You only have to pay interest on a HELOC when you borrow against it. Some homeowners obtain a HELOC “just in case” and rarely use it. This funding source can provide immediate proceeds at will, but some people use it as a backup for short-term expenses. Of course, you can borrow up to your limit right away if you desire, but not every homeowner approaches HELOCs with that mentality.
Home Equity Loan
Most lenders only let you borrow up to 80% of your home’s equity minus your mortgage balance. Home equity loans let you make fixed monthly payments on your proceeds. HELOCs have more flexibility regarding how much you can take out and when, but those financing products have variable rates. If interest rates continue to rise, HELOC borrowers can face an uphill battle with future repayments.
A home equity loan acts as a second mortgage. This loan does not replace your current mortgage. Homeowners who secured lower interest rates with their first mortgage won’t have to worry about higher monthly costs on their current structure. However, this type of financing isn’t the best approach for debt-free home equity financing. A home equity loan works well if you can afford the monthly payments, but if you feel a strain on your budget, keeping up can get stressful.
Cash-out Refinance
Homeowners seeking a cash-out refinance can borrow up to 80% of their home equity minus the existing mortgage. A cash-out refinance replaces your old loan with a new loan. You can use a refinance to secure a lower interest rate or adjust your loan’s terms. For example, some people add a few years to the backend of the loan to reduce monthly payments. This approach can alleviate paying for the cash-out over time. Homeowners can also shorten the loan’s term to rebuild equity sooner. A cash-out refinance is optimal if you want to replace your current loan. Homeowners who want to keep their first mortgage may consider a home equity loan or HELOC instead.
Equity Sharing Agreements
The previously mentioned home equity financing options let you tap into the position you have built in your home. Obtaining these funds can help with essential purchases and make you feel financially safer. However, those funding sources increase your debt, and monthly payments can take a toll. Late payments will hurt your credit, and interest will continue to accumulate.
Equity-sharing agreements are a new option for homeowners who want to access equity without going into debt. You can access your home equity without monthly payments or high interest rates.
What Can You Use the Funds from Your Home Equity For?
You do not have to inform the lender about how you will use home equity funds. Home equity is your money, and you can use it in any way you desire. However, here are some expenses that frequently result in people using their home equity.
- Medical bills: Minimize the financial stress of medical bills by letting your home equity do some of the work.
- Vacation: Trips can get expensive, and home equity can help. You can use your home equity to cover any vacation expenses.
- Home repairs or improvements: You can use home equity to improve your home. This investment will let you tap into more home equity in the future.
- Retirement: Some people use reverse mortgages and receive monthly payouts from their home equity. You can also obtain a lump sum and use the home equity to cover living expenses. However, this isn’t a good idea for everyone due to the risk of running out of home equity while you are still alive.
- Tuition: The equity you built in your can help you keep up with college tuition for your children.
- Debt: Home equity usually has lower interest rates than other types of debt. You can use home equity to consolidate high-interest debt like credit card debt.
How Much Equity You Can Borrow: The Bottom Line
Several factors impact your ability to tap into home equity. A higher credit score, lower debt, and a low debt-to-income ratio can all help you tap into more of your home’s equity. Each monthly mortgage payment will build up your home equity in case you need to tap into it. Not everyone needs to borrow from their home equity, but knowing this is an option can minimize financial stress.
