The equity in your home can give you a number of financial benefits. You can borrow against it to consolidate debt, to make home improvements or just to have money on hand for an emergency. How much equity you can actually access depends on several factors. The appropriate loan-to-value ratio, or LTV, must be within the lender’s limits. And you must be able to afford the payments on the equity.
Equity is the maximum lendable value of your house minus any existing liens. To calculate equity, you need to know the lender’s advance rate, the value of your property, and the principal balance of your existing liens. If your lender advances up to 80 percent of the value of your home and the house is worth $300,000, your maximum lendable value is $240,000. If you have a first mortgage with a $200,000 balance, you have $40,000 in equity.
The LTV limits that determine your equity depend on the lender, the loan type and the property. Most home equity loans have an LTV ratio between 80 and 85 percent, depending on the lender, as long as the property is the borrower's primary residence. A rental property, on the other hand, is considered riskier because repayment is based partially on your ability to keep a tenant in there. Because of this, lenders allow only 70 to 75 percent LTV on an investment home. Vacant land is even riskier, with LTV as low as 35 percent.
Although property value is the driving force in determining how much equity exists in your home, your debt-to-income ratio will tell you exactly how much of that you can access. When a lender reviews your loan request, it calculates the debt-to-income ratio to determine your ability to repay the loan. You might have $100,000 in equity per the appraised value of the home, but you might be able to support the payments on only a $50,000 loan. Most lenders want a debt-to-income ratio of no more than 40 to 45 percent.
If you do have the income to support a higher payment but you need more than 85 percent of the value of your home, you can access that additional equity by refinancing with cash out. On a conventional mortgage you can get up to 95 percent, while you can get 97 percent on a loan insured by the Federal Housing Administration. However, these loans require you to pay for private mortgage insurance. This PMI is an additional monthly premium that you will have to pay until you reach 78 percent LTV. On an FHA loan, you must pay the mortgage insurance premium for a minimum of five years regardless of the LTV. If you’re desperate this could be an option, but the extra expense might mean it's not worth it.