You’re considering a home equity loan but aren’t sure how much you can borrow. It depends on how much of your home you own outright. More specifically, lenders calculate the difference between your home’s market value and what’s owed on your mortgage to make a decision. They also assess your creditworthiness and other financial factors.
Read on to learn more about home equity loans and how to determine how much funding you can potentially access.
Understanding Home Equity Loans
Before diving into the specifics of the home equity loan calculation, it’s worth understanding how these loan products work.
What is a Home Equity Loan?
A home equity loan is a tool for converting a portion of your outright ownership into cash. It acts as a second mortgage and uses your home as security.
How Do Home Equity Loans Work?
When you apply for a home equity loan, the lender reviews your credit and financial information to ensure you meet the eligibility guidelines. An appraisal is also required to compute the current market value of your home.
Most lenders cap the loan amount at 85% of your home equity. So, if your home is valued at $450,000 and you owe $285,000 on your mortgage, you could potentially access a home equity loan of up to $97,500 ($450,000 * .85 – $285,000).
If you decide to move forward, you’ll receive a lump sum payment of xx once the loan closes. The amount you borrow is payable in equal monthly installments over a set period – usually from 5 to 30 years – since the interest rate is fixed.
Calculating Your Home Equity
Below is a closer look at the steps involved in computing home equity.
Determining Your Home’s Current Market Value
A quick online search on any of the popular real estate websites will give you an estimate of your home’s worth. But the lender won’t rely on this number. Instead, they will order a professional appraisal to get a more concrete figure.
Calculating Your Outstanding Mortgage Balance
It’s easy to find your outstanding mortgage balance. Simply browse your most recent mortgage statement and highlight the principal balance listed. You can also log in to the online portal to find this figure or call the mortgage servicer directly. If the lender charges early repayment penalties, be sure to note the cost.
How to Calculate Home Equity
Once you have your home’s current market value and the amount you owe on your mortgage handy, it’s time to calculate your home equity. You can do so using this equation:
- Current market value of your home – Outstanding mortgage balance = Home Equity
To illustrate, if your home’s current market value is $395,000 and your outstanding mortgage balance is $295,000, you have $100,000 in home equity. This figure is computed by subtracting the $295,000 you owe on your mortgage from its value of $395,000.
Loan-to-Value (LTV) Ratio
Lenders also assess your LTV ratio to decide if you’re a good fit for a home equity loan.
What is the LTV Ratio?
The LTV is computed by dividing your current mortgage balance by the appraised value of your home. A lower LTV means less risk to the lender, and it could equate to better loan terms for you.
Typical LTV Ratios for Home Equity Loans
Your LTV should not exceed 85% to have the best chance of getting approved for a home equity loan. Using the example above, the LTV ratio would be 75% ($295,000 / $395,000), which is acceptable to most lenders.
Factors Influencing Your Home Equity Loan Amount
Several factors influence your eligibility for a home equity loan.
Credit Score and History
A good or excellent credit score helps you access the most attractive rates on a home equity loan. Any score above 700 is ideal, but some lenders go as low as 620. If your score is on the lower end, though, you’ll likely pay far more in borrowing costs over the loan term.
Debt-to-Income Ratio
Lenders also consider your debt-to-income (DTI) ratio when you apply for a home equity loan. It’s the percentage of monthly gross income used to cover monthly debt payments, and it should be below 43% for the best approval odds. So, if you earn $7,000, it’s best if the amount paid monthly for debts is below $3,010 ($7,000 * .43).
Some lenders are a bit more flexible than others and may allow a higher DTI. However, they will likely look for other compensating factors, like a higher credit score or more equity, to make an exception.
Employment and Income Stability
You’ll need to prove that you have the means to make timely monthly payments on the home equity loan. Lenders will check your employment history and verify your income to confirm you can afford to take on an additional loan payment. If you’re self-employed or have gaps in your employment history, be prepared to provide additional documentation and an explanation, respectively.
Property Type and Location
The property type and location are considered by lenders when determining how much of a home equity loan you’re eligible for. If your home is a hot commodity and there’s high demand in your area, you could unlock more borrowing power.
Keep in mind that single-family homes generally come with more attractive loan terms than condos or multi-family properties.
Maximum Limits and Restrictions
Here’s what to know about loan limits.
Lender-Specific Limits
Again, most lenders cap home equity loans at 85% of your home’s value minus your outstanding mortgage balance. However, some limit the ceiling to 80% or lower, depending on your creditworthiness and overall financial profile.
Legal and Regulatory Restrictions
In some states, there are limitations on the amounts homeowners can access through home equity loans. These regulations are in place to shield consumers from accumulating too much debt.
Factors Limiting Borrowing Capacity
Your credit score, debt-to-income ratio, LTV, income and employment history are all factors that could curb your borrowing power. Remember, lenders want reassurance that you can afford to repay what you borrow and may limit the loan amount to help ensure the monthly payments are reasonable.
Steps to Determine How Much You Can Borrow
When you’re ready to take out a home equity loan, these step-by-step instructions can help you determine your borrowing power.
Step-by-Step Guide to Estimating Your Loan Amount
- Step 1: Get an estimate of your current property value.
- Step 2: Retrieve your outstanding mortgage balance.
- Step 3: Multiply your current property value by the maximum amount of home equity you can access per the lender.
- Step 4: Subtract your mortgage balance from the figure calculated in Step 3 to estimate your borrowing power.
Here’s a breakdown of how this works if your home is worth $410,000, you owe $260,000, and the lender lets you borrow up to 80% in equity:
- Step 1: $410,000
- Step 2: $260,000
- Step 3: $410,000 * .80 = $328,000
- Step 4: $328,000 – $260,000 = $68,000
Using Online Home Equity Loan Calculators
You don’t have to do the legwork on your own. Instead, you can use a free online home equity calculator to estimate your borrowing power. To get an answer, you’ll need to input your home’s market value, outstanding mortgage balance, zip code and credit score range.
Consulting with Lenders
It’s worth connecting with at least three lenders to get an idea of what to expect. Some offer online pre-qualification, which allows you to view loan quotes without impacting your credit score. Compare the estimates, including the maximum loan amounts, monthly payments, interest and lending fees, to get a more solid idea of how much you can borrow.
Improving Your Eligibility
If you retrieved loan estimates but weren’t pleased with the figures, you’re not completely out of luck. The same applies if you were denied a home equity loan due to issues with your credit or financial profile. Here are some tips to help improve your eligibility or boost your approval odds.
Strategies to Increase Home Equity
There are two primary ways to increase your home equity. You can pay down your mortgage principal faster or make home improvements that boost your home’s value. It’s also important to maintain your home to help preserve its value as it increases.
Tips to Improve Your Credit Score
Visit AnnualCreditReport.com and download free copies of your credit reports from the three major credit bureaus – Experian, TransUnion and Equifax. Review each report in its entirety, highlight any errors or outdated information and file disputes with the applicable credit reporting agency promptly.
Other tips to improve your credit include:
- Paying your bills on time and bringing any past-due accounts current
- Lowering your credit utilization rate by paying down balances on credit cards and lines of credit
- Refraining from closing old credit accounts in good standing
- Only applying for new credit as needed to minimize hard credit inquiries
- Keeping tabs on your credit profile to ensure your score is trending in the right direction
Managing Your Debt-to-Income Ratio
Calculate your DTI to see where you stand. As a reminder, you can calculate it by dividing your total monthly debt payments by your gross monthly income. It should be below 43% to have the best chance of getting approved for a home equity loan with favorable terms.
If your DTI is on the higher end, try paying down your balances revolving debts (i.e., credit card) to bring the monthly payments down. You can also boost your income by taking on a part-time job or side gig to give yourself more wiggle room and help improve your DTI.
Conclusion: Maximizing How Much Home Equity Loan You Can Get
The amount of your home equity loan depends on how much of your home you own outright. Lenders also consider your creditworthiness, employment history, income, current debt load and LTV. Be sure to educate yourself on how home equity loans work and implement the strategies listed in this guide to maximize your home equity and borrowing power.
