Next, take a look at how banks calculate equity

Mortgage, refinance and home equity loan providers may use additional calculations when deciding how much they’re willing to lend you — or even whether they’re willing to lend to you at all. One measure they use is the loan-to-value (LTV) ratio. When you first apply for a mortgage, this number reflects the amount of the loan you’re seeking relative to the home’s value. If you have a mortgage, your LTV ratio is based on your loan balance. Your LTV ratio can affect whether you pay private mortgage insurance or if you might qualify to refinance. With a higher LTV ratio, banks may consider your loan higher risk, which can increase your borrowing costs. A professional appraisal is key to accurately figuring out your LTV ratio. That’s why your lender often will require an on-site appraisal as part of the process for obtaining a loan. To figure out your LTV ratio, divide your current loan balance (you can find this number on your monthly statement or online account) by your home’s appraised value. Multiply by 100 to convert this number to a percentage. Caroline’s loan-to-value ratio is 35%.

Possible effects on insurance

If you pay private mortgage insurance (PMI) on your mortgage, keep an eye on your LTV ratio. Your lender is required by federal law to cancel PMI when a home’s LTV ratio is 78% or lower than the home’s original appraised value (provided certain requirements are met). This cancellation is generally preplanned for when your loan balance reaches that percentage. However, if your LTV ratio drops below 80% because of extra payments you made, you have the right to request your lender cancel your PMI. You can also ask your lender to cancel your PMI if the value of your home has increased, which will lower your LTV ratio. But in that case, you may need a new appraisal, and other rules apply, including the length of time you’ve owned your home.

What about home equity loans?

If you’re considering a home equity loan or line of credit, another important calculation is your combined loan-to-value (CLTV) ratio. Your CLTV ratio compares the value of your home with the combined total of the loans secured by it, including the loan or line of credit you’re seeking. Say Caroline wants to apply for a $75,000 home equity line of credit. She calculates what her CLTV ratio would be if she were approved for it and, since most lenders require your CLTV ratio to be below 85% to qualify for a home equity line of credit, Caroline likely would be eligible.

Ways to potentially increase your equity

If your home’s value remains stable, you can build equity (lower your LTV ratio) by paying down your loan’s principal. If your payments are amortized (that is, based on a schedule by which you’d repay your loan in full by the end of its term), this happens automatically simply by making your monthly payments. To lower your LTV ratio more quickly, consider paying more than your required payment each month. This helps you chip away at your loan balance. (Check first to make sure your loan doesn’t carry any prepayment penalties.)

Also, protect the value of your home by keeping it neat and well-maintained. Smart home improvements can help, too. However, it’s a good idea to consult an appraiser or real estate professional before investing in any renovations you hope will increase your home’s value. Remember that economic conditions — and the normal dips and swings of the real estate market — can affect your home’s value no matter what you do. If the value of your home increases due to a renovation project, your LTV ratio could drop, depending on how much equity you tapped to cover the costs. But falling home prices in your area could cancel out the value of any improvements you might make.

Building up equity in your home can help you pursue other important goals and provide a financial buffer in case of emergencies. The first step to taking advantage of it is knowing how much you have.

This article was adapted from Better Money Habits®. Visit BetterMoneyHabits.com for more practical financial information.