What is a HELOC?
A HELOC gives you a line of credit during the draw period that you can use to pay for items as needed. Once the draw period ends, the total outstanding loan amount will be divided into regular monthly payments. During the repayment period, you will need to pay the minimum amount every month until you’ve repaid all the money you spent during the draw period plus interest. A home equity loan gives you access to a lump sum that you can use for repairs and other projects. You will then have to make fixed monthly payments, plus interest until the debt is paid off. Loan terms vary from lender to lender, so read through the agreement to understand the total costs of your home equity loan payments.
The amount of equity available for a home equity loan or home equity line of credit is determined by the loan-to-value (LTV) ratio of the home and the ratio requirements of the lender. Every lender has their requirements for these loans, but the sum of the remaining balance on your mortgage and the total loan amount cannot exceed 85% of your home's appraisal value.
Calculating loan-to-value ratio
A loan-to-value ratio is calculated by taking total mortgage debt (including any second mortgages or existing home equity loans) and dividing it by the current, appraised value of the home.
To calculate your LTV ratio, divide the current balance on your mortgage by the current appraisal value of your home. The market value of your home may have changed since you first purchased the property. And some lenders may require another appraisal to get a more accurate estimate of the home’s value. You can also compare the purchase price of similar homes in the neighborhood to get a rough idea of your home's worth.
For example, let’s say your home is currently valued at $450,000, and you still owe $150,000 on your mortgage. Thus, 150,000 / 450,000 = 33.33%. That means you still owe 33.33% of the equity in your home. Subtract this number from 100 to calculate how much equity you have built in your home. This means you have 67% equity in your home.
Now that you’ve calculated the LTV ratio of your home, you can determine how much money you can borrow with a HELOC or home equity loan. The combined loan-to-value ratio of your loans cannot exceed 85% of the home’s value. To find out how much you can borrow, multiply your home’s appraisal value by 0.85 and then subtract the remaining balance on your mortgage from the total.
Using the example above, 85% of the home’s value would be $382,500 ($450,00 x 0.85). If you have 67% equity in your home and still owe $150,000 on your mortgage, you can borrow up to $232,500 as a HELOC or home equity loan. ($382,500 - $150,000).
