Equity and LTV are two sides of the same coin. They are both calculated from the amount of the mortgage and the value of the home, but they are used for different purposes.
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You can think of equity as the amount of your home’s value that you actually own while you are in the process of paying off your mortgage.
You can express it as a dollar amount by subtracting the money you still owe on your mortgage from the value of your home. For example, if your home is worth $200,000, and you still owe $150,000 on your mortgage, then you have $50,000 of equity built up in your home.
Home Value – Remaining Mortgage Amount = Equity Example: $200,000 – $150,000 = $50,000
With every mortgage payment you make, your equity grows, and this is what makes buying a home a better investment than renting in many cases. The equity you have in your home can be your greatest financial asset.
Rising equity can more than compensate for the costs of homeownership.
Because equity is tied to the value of your home, it will also change independently of your mortgage payments. Whenever the housing market heats up or your neighborhood becomes more desirable, your equity will rise without you having to pay an extra cent. You can also increase your home’s value by doing certain renovations to add amenities.
Equity can decrease when a downturn in the economy causes home prices to fall. Even then, however, your equity will be growing slowly but surely as you make your mortgage payments, and low periods like these are the best times to buy a home, since both prices and interest rates will be lower.
During the Great Recession, home prices fell so much that some homeowners actually wound up owing more on their mortgages than their homes were worth. This situation is called negative equity, or “being upside-down on the home.”
Help from HARPThe Home Affordability Refinance Program (HARP) was created in 2009 to help people who are “underwater” or “upside-down” in their mortgages. HARP is set to expire in September 2017. Streamline refinance programs with no equity requirements are also available through the FHA and the VA.
You can think of the loan-to-value ratio, or LTV, as expressing what percentage of the home is covered by the loan. If we use the same numbers as in our example above, it gives you an LTV of 75 percent.
Remaining Mortgage Amount / Home Value = LTV Example: $150,000 / $200,000 = 75%
Lenders look carefully at the LTV when you apply for a mortgage. A higher LTV means a riskier investment, and lenders will set stricter qualifying requirements and a higher interest rate to compensate. There are also federal regulations regarding the LTV.
A high LTV will make it difficult to refinance a mortgage with a conventional loan.
If you are purchasing a home, you may have to increase your down payment in order to lower the LTV to an acceptable level. A high LTV will also make it difficult for you to refinance a mortgage. FHA loans, VA loans, and HARP loans all exist to make mortgages available even when the LTV is high.
Also bear in mind that when the LTV is 80% or higher, you are usually required to pay mortgage insurance. The good news is that once you have paid down your mortgage enough that your LTV drops below 80%, you can usually request to cancel the mortgage insurance.