The more equity you’ve got in your home, the more of the house you really own. Equity is the amount of your home’s value that isn’t encumbered by a mortgage or other loans. When banks look to lend you money for a mortgage or a home equity loan, the value of your home and of your equity will affect the rate of interest you may get.
Appraisal
The very first step for a lender figuring the value of your home or the home you wish to purchase is an assessment, the All Area Appraisal Affiliates Network states. The home will inspect your home, looking at the dimensions of the living space, the dimensions of other spaces like the garage, cellar and deck, the number of bedrooms and baths, and special attributes or serious flaws.
Neighborhood
The appraiser will then identify homes that have characteristics similar to yours, in similar neighborhoods–violent areas shouldn’t be compared to tranquil roads –that have sold in the past year. The prices those homes sold for will give an idea of the current market value for the residence.
Debt-to-Value Ratio
If you are applying for a mortgage, then the value of the house above the amount of the mortgage you are asking for signifies your first equity. The ratio of loan to value is very important for creditors, according to Lending Tree, since the equity you have the less likely you are to give up the default and house. Anything greater than an 80 percent debt-to-value ratio will probably lead to higher rates and need mortgage insurance.
Home Equity Loans
Your mortgage isn’t the one thing that affects your equity: any debt that uses your home as collateral, like a home equity loan or line of credit, will also reduce your equity. Bankers creating a home equity loanalso known as a second mortgagewill check the debt-to-value ratio as well. As with a first mortgage, if borrowing from your home reduces equity to less than 80 percent, the rates will be greater.
Down Payment
If you can not make a down payment of at least 20 percent, you won’t meet the 80 percent loan-to-value standard, meaning higher interest or no mortgage at all. 1 way to prevent that is to apply for mortgage insurance from the Federal Housing Administration. When the FHA covers a mortgage, then banks will take as small as a 3.5 percent down payment. The Washington Post reported in 2010 that some members of Congress want to increase the minimum to 5 percent, but that the Obama administration opposes the idea.