If you’re taking out a home equity line of credit, the amount of available equity you have in your home plays an important role. Your home equity is the difference between the appraised value of your home and your current mortgage balance(s). The more equity you have, the more financing options may be available to you.
Your equity helps your lender determine your loan-to-value ratio (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 private mortgage insurance (PMI). To avoid PMI, your LTV typically needs to be 80% or less, but PMI applies only to first liens so if your home equity line of credit is a second lien against your house, you shouldn't have to worry about paying PMI.
Calculating your loan-to-value ratio
Your loan-to-value ratio (LTV) is another way of expressing how much you still owe on your current mortgage. Here‘s the basic loan-to-value ratio formula:
Current loan balance ÷ Current appraised value = LTV
Example: You currently have a loan balance of $140,000 (you can find your loan balance 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%.
Combined loan-to-value ratio (CLTV) for more than one loan
If you are considering a home equity line of credit, 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 = CLTV
Example: You currently have a loan balance of $140,000 (you can find your loan balance on your monthly loan statement or online account) and you want to take out a $25,000 home equity line of credit. Your home currently appraises for $200,000. So your combined loan-to-value equation would look like this:
$165,000 ÷ $200,000 = .825
Convert .825 to a percentage, and that gives you a combined loan-to-value ratio of 82.5%.
Most lenders require your CLTV to be 85% or less for a home equity 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.
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 certified appraiser to come to your home and estimate its value. Learn more about the home appraisal process
How to impact your LTV
One of the best ways to help reduce your loan-to-value ratio is to pay down your home loan’s principal on a regular basis. This happens over time simply by making your monthly payments, assuming that they’re amortized (that is, based on a payment schedule by which you’d repay your loan in full by the end of the 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 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.
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. 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.