In the financial world, says Phil Thow, it is important to understand the workings of equity and loan to value. When you are looking to get financing, or to refinance using some asset as collateral, you will need to know the value of that asset and how much you can feasibly borrow against it. Phil Thow says having this information before actually seeking out financing is important and will save some time in the process. The easiest way to understand these concepts is to equate them to home ownership, even though it can apply to business financing as well.

Say you have a mortgage on your house and you have had it for a while, maybe ten years or so. In that 10 years you have made mortgage payments which have added to your equity in the house in addition to the equity achieved through market appreciation. Now, you want to add a deck or garage or something, and you don’t have the ready cash to pay for it. This is where equity and loan to value comes in. You may want to take out a loan against the equity in your home to pay for the addition. The bank will typically lend you a percentage of the equity you have in the home against it. In essence, you are borrowing from yourself but paying the interest to the bank. This is often better way to finance than taking out an additional loan, according to Phil Thow.

The interest you will pay on equity and loan to value is a lot less than a personal note or credit card and is most likely the more prudent way to borrow money. Loan to value refers to the ratio of the value of the house compared to what you wish to borrow. If you need 50,000 and your house is worth 100,000, loan to value is 50%. This the bank uses along with other credit considerations to decide what amount they are willing to risk in a loan to an individual, or a business. Phil Thow suggests knowing this number at all times is good policy. Phil Thow advises that in terms of a financial tool, having a good grip on your equity and loan to value situation will make financial decisions a lot easier and will take less time. It is a good indicator of financial well being and of liquidity.