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Home Equity Loan Basics

Evaluating the Equity in Your Home

If you’re considering Glossary Term: refinancing your Glossary Term: mortgage or taking out a Glossary Term: home equity loan or Glossary Term: line of credit, the amount of available Glossary Term: equity you have in your home plays an important role. Your home equity is the difference between the Glossary Term: appraised value of your home and your current mortgage balance(s). The more equity you have, the more refinancing options available to you.

Your equity helps your Glossary Term: lender determine your Glossary Term: loan-to-value ratio (or LTV), which is one of the factors your lender will consider when deciding whether or not to approve your application. It also helps your lender determine whether or not you’ll have to pay for Glossary Term: private mortgage insurance (PMI). To avoid PMI, your LTV needs to be 80% or less.

Calculating your loan-to-value ratio

Your loan-to-value ratio is another way of expressing how much you still owe on your current mortgage. Here is the basic loan-to-value ratio formula for a refinance:

Current Loan Balance ÷ Current Appraised Value

For example: You currently have a loan balance of $140,000 (you can find this number on your monthly loan statement or online account). Your home currently appraises for $200,000. So your loan-to-value equation would look like this:

$140,000 ÷ $200,000 = .70

Convert .70 to a percentage, and that gives you a loan-to-value ratio of 70%.

If your lender’s guideline for an allowable refinance loan amount is 80%, then you would meet that requirement in this example.

If you want to refinance and you have an excellent credit score and a low amount of outstanding Glossary Term: debt, your lender may allow you to refinance at a higher loan-to-value ratio. Some loans may be available for up to 95% of the appraised value of the home.

Combined loan-to-value (CLTV) for more than one loan

If you are considering a home equity loan or line of credit (also called “second mortgages”), you would add the amount you want to borrow or the credit limit you want to establish to your current mortgage balance. This would give you your combined loan balance and your combined loan-to-value formula would look like this:

Current Combined Loan Balance ÷ Current Appraised Value

Most lenders require your CLTV to be 85% or less for a home equity loan or line of credit. If your CLTV is too high, you can either pay down your current loan amount or wait to see if your home’s value increases.

The appraisal

A professional Glossary Term: appraisal is an essential part of determining your loan-to-value ratio. If an onsite appraisal is needed, your lender will arrange for a certified Glossary Term: appraiser to come to your home and calculate its value.

How to impact your LTV ratio

The best way to reduce your loan-to-value ratio is to pay down your home loan’s Glossary Term: principal on a regular basis. This happens over time simply by making your Glossary Term: monthly payments, assuming that they are amortized (that is, based on a payment schedule by which you’d repay your loan in full by the end of the Glossary Term: loan term). You can reduce your loan principal faster by paying a little bit more than your amortized mortgage payment each month (ask your lender if you will have to pay Glossary Term: prepayment penalties if you do this).

Another way to impact your loan-to-value ratio is by protecting the value of your home by keeping it neat and well maintained.

Homeowner Tip:

Making smart improvements could positively affect an appraisal. It’s a good idea to consult an appraiser or a real estate professional for advice before investing in any home improvements. And keep in mind that economic conditions can have a negative impact on home values regardless of improvements you make to your home.

Now that you know how to calculate your loan-to-value and combined loan to value ratios and how you can impact them, you can make more informed choices to help you reach your financial goals, whether you choose to borrow from the equity in your home, refinance, or simply continue to pay down any current home loan balances.