Your debt-to-equity ratio is an important number. It tells you whether you can qualify for a traditional refinance or if you've built up enough equity to take out a home equity loan or line of credit. Ideally, the equity in your home will steadily grow after you purchase it -- but that might not happen if your home's value has fallen since you purchased it.
Debt and Equity
Your debt-to-equity ratio measures the relationship between how much you owe on your mortgage loan and your home's value. If your home is valued at $250,000 and you owe $180,000 on your mortgage loan, your equity stands at $70,000. You calculate your debt-to-equity ratio by dividing your debt into your home's current value. In this case, $180,000 divided into $250,000 comes out to 72 percent. This means that your debt-to-equity ratio stands at 72/28. Your debt is equal to 72 percent of your home's market value.
Real estate appraisers play an important role in figuring your debt-to-equity ratio. When you apply for a home equity loan or home equity line of credit, or when you apply for a refinance of your existing loan, your lender will send an appraiser to your home to determine its current market value. The appraiser will do this by touring your home, checking for updates and analyzing the sales of similar homes in your neighborhood. Once the appraiser determines the home's market value, and you know how much you owe on your mortgage loan, you can determine your debt-to-equity ratio.
You'll need to know your debt-to-equity ratio when applying for a refinance. That's because most lenders won't approve you for a refinance unless you have a debt-to-equity ratio of at least 80/20, meaning that you have at least 20 percent equity built up in your home. There are options for refinancing if your debt-to-equity ratio is higher than 80/20. The government, for example, offers its Home Affordable Refinance Program for those homeowners who have little or negative equity. A standard refinance, though, is usually a less complicated process.
Borrowing Against Your Equity
You'll need to know your debt-to-equity ratio if you'd like to borrow against your equity through either a home equity loan or home equity line of credit. A home equity loan is a second mortgage, while a home equity line of credit acts more like a credit card. These two products allow you to tap into your home's equity and then use that money to pay down credit cards with high interest rates, fund a major home improvement, pay for a child's college education or cover any other cost you'd like. Lenders, though, will provide you with a home equity line of credit or home equity loan only up to a percentage of your equity. If you have equity of $80,000, your lender might only allow you borrow up to $60,000.
Don Rafner has been writing professionally since 1992, with work published in "The Washington Post," "Chicago Tribune," "Phoenix Magazine" and several trade magazines. He is also the managing editor of "Midwest Real Estate News." He specializes in writing about mortgage lending, personal finance, business and real-estate topics. He holds a Bachelor of Arts in journalism from the University of Illinois.