How to calculate home equity: A guide for mortgage brokers

Helping homebuyers understand and calculate their home equity can open the doors to new financing options and better property loan terms. Whether your clients are looking to refinance, apply for a home equity loan, or sell their property, determining how much home equity they have is vital. 

In this article, Mortgage Professional America will discuss everything about calculating your home equity. We will discuss how mortgage brokers can help their clients find out how much their home is worth and how to build equity. Want to know how much of your clients’ home equity they can borrow? Read on to find out. 

How do I calculate my home equity? 

Home equity is the difference between what a property is worth and the amount still owed on the mortgage. It refers to how much of the property has been paid off. It represents your clients’ stake in the home compared to that of the bank or mortgage lender. 

To explain it clearly, you can use this formula to calculate one’s home equity: 

There are two steps to calculating your home equity: 

1. get a current market value estimate for your clients’ home 
2. subtract your clients’ mortgage balance 

Here is a closer look at each: 

1. Get a current market value estimate for your clients’ home 

Your clients’ homes could be worth more today or less than when they purchased them. Because the housing market shifts regularly, it’s critical to get a current estimate of the property’s value. 

You can use online home value estimator tools that are available. However, it might be a better idea for your clients to speak with a licensed appraiser or a local real estate agent. This way, they can get a more accurate and up-to-date estimate. 

2. Subtract your clients’ mortgage balance 

After your clients determine the market value of their property, they can subtract what they still owe on the mortgage. They can also subtract any other debts secured by the home. The result from that subtraction is their home equity. 

Watch this video to better understand how to calculate your home equity: 

Aside from helping your clients calculate their home equity, they might also ask for assistance in getting an estimate of their monthly mortgage payments. Try using our free mortgage calculator to help them! You can also use it to show your clients their total interest costs. 

How to build home equity 

There are a few ways your clients can build equity in their homes: 

1. make regular mortgage payments 
2. go for home improvements that add value 
3. put down a large down payment 

Let’s take a more in-depth look at each: 

1. Make regular mortgage payments 

Making their mortgage payments regularly is one of the most straightforward ways for your clients to increase equity in their home. With each month they make a payment, they pay down the loan balance and build equity. 

If they want to build equity faster and have the funds, they can make additional payments toward the mortgage principal. 

2. Go for home improvements that add value 

If your clients make home improvements that raise the value of their property, they will increase their equity. However, their mortgage principal will stay the same. When helping clients build home equity, remind them that some improvements add more value than others. 

As such, remind them to focus on upgrades with higher returns as not all improvements add equal value. 

3. Put down a big down payment 

Your clients can increase home equity right away by making a large down payment when they buy a property. If they can afford it, suggest paying 20 percent instead of 10 percent. This approach will help them build equity more quickly and can give them earlier access to that equity if needed. 

If they make a 20 percent down payment on their purchase, they can also avoid paying for private mortgage insurance (PMI). 

When not to use calculated home equity 

Before helping your clients decide whether to tap into their home equity, it’s important to make sure that they understand the risks involved. One major reason for this is that home equity loans are secured by their property. 

Here are some reasons why it might be best for your clients to avoid a home equity loan even after calculating their home equity: 

1. to free up short-term cash flow 
2. to purchase a vehicle 
3. to fund a vacation  
4. to pay for post-secondary education 
5. to repay other debts 
6. to invest in real estate  

Here is a closer look at each:  

1. To free up short-term cash flow 

Your clients should usually avoid using funds from a home equity loan to handle day-to-day monetary concerns that they might be having. The home equity loan must still be repaid, and missing payments could put them deeper in debt. 

If your clients cannot manage the monthly repayments, the situation might become worse. Without a clear plan to repay the loan, calculating their home equity and using it might add to their financial stress rather than solve it. 

2. To purchase a vehicle 

Using a home equity loan to buy a new vehicle is generally not a good idea. It often means that your clients are shifting debt instead of solving the underlying issue, which is usually poor spending habits. This approach can lead to more monetary problems instead of resolving existing ones. 

3. To fund a vacation 

If your clients use a home equity loan to fund leisure activities like vacations, they might be spending beyond their means. Relying on equity to support their lifestyle choices can increase their debt and make their financial situation more difficult over time. 

4. To pay for post-secondary education  

Using a home equity loan to cover post-secondary education is risky, even if education is often seen as a smart investment. Your clients shouldn’t have to risk their home to pay for tuition, especially when there are other ways to fund it. 

If they are considering using home equity, encourage them to explore safer alternatives first such as: 

• Federal Work-Study Program 
• Federal student aid 
• grants 
• loans 
• scholarships 

5. To repay other debts 

Even though home equity loans might have lower interest rates than other types of debt, that alone doesn’t make them a good solution. This is especially true if your clients want to borrow the maximum amount available for the loan. 

Doing so can put them at risk of being upside down on the loan. Instead of relying on home equity to pay off high-interest debt, help your clients identify and fix the root cause. 

6. To invest in real estate  

Investing in real estate is mostly speculative and property values tend to fluctuate. Even if your clients’ investment turns out well, they might still have trouble recovering enough money to repay their home equity loan. 

How home equity loans work 

Home equity loans and home equity lines of credit (HELOCs) use the equity that your clients have built in their homes as collateral. With this, banks and mortgage lenders might offer competitive interest rates, just like what they offer to borrowers who are buying property for the first time. 

Learn more about home equity loans when you watch this: 

There are some factors that can affect your clients’ eligibility for a home equity loan. These include: 

• credit score 
• income 
• employment history 

Another consideration is whether your clients take out a reverse mortgage. All these can influence the interest rate that they will be offered. For instance, a lower credit score might indicate a higher risk of default. This can lead the bank or mortgage lender to offer a higher rate or reduce the approved loan amount. 

Learn how to get a better credit score to buy a house in this guide.

CLTV ratio and borrowing limits 

Because the home is used as security, there is a limit on how much your clients can borrow. Banks, credit unions, or other mortgage providers might lend between 80 percent and 85 percent of the combined loan-to-value (CLTV) ratio. 

To calculate a CLTV ratio, divide the total of all loans tied to your clients’ property, including the new loan amount, by the current value of the property. 

Why calculating home equity matters 

Helping your clients calculate their home equity gives them an idea of their financial standing as well as the opportunities that they can get. Knowing how much equity your clients have is critical especially when they want to refinance or sell their home. 

If your clients are aware of the benefits and risks tied to their equity, they’re more likely to be responsible when considering using it. As their mortgage broker, you can position yourself as a reliable professional in determining home equity. In the end, your expertise can lead to more referrals from satisfied clients. 

Visit Mortgage Professional’s Guides section for more resources on home equity loans and other mortgage types