There are so many reasons why homeowners choose to refinance. The chance to secure a shorter or longer term, reduced monthly installments, competitive interest rates, owning the home sooner, switching to a fixed or adjustable-rate...there's a variety of things you can accomplish with a mortgage refinance.
But what about the equity you have spent years building? Will some of that effort be wasted? Valid questions to ask, especially considering there are upfront refinancing costs to consider. If you're contemplating a refinance, here's what you need to know about how that move will affect your home equity.
Home equity represents the amount of your home that you own. It's calculated by taking your home's market value and subtracting your mortgage balance. For example, if your home is worth $500,000 and you owe $300,000 on your mortgage, your home equity is $200,000.
Why is equity important?
It allows you to convert assets into cash.
From a cash-out refinance to a home equity loan or a home equity line of credit, there are many ways you can tap into your equity to cover major expenses. Many view home equity as a way to build wealth over time and equity is often considered to be a homeowner's most valuable asset.
So, how does one build equity? There are two ways to do so; increase your property value and decrease the amount you owe on your mortgage. Doing both will help you build up equity more quickly. There are many ways you can quickly boost your home's appraisal value. Additionally, paying your installments on time, making a large down payment, and making extra payments toward your principal can help you reduce the amount you owe, thus, building equity.
Can You Lose Equity?
Just as you can increase your home equity, you can lose it. Here are the most common ways homeowners lose equity:
- Letting the home fall into disarray
- A downturn in the market/local real estate
- Increasing your loan amount
How can you increase your loan amount? By refinancing.
Equity Requirements for Refinancing
Typically speaking, most lenders require homeowners to have 20% equity if they're looking for a conventional refinance. Some do allow lower amounts, but that means you'll likely be hit with high interest fees and rates, so you'll have to carefully review the outcome to ensure the refinance helps you accomplish your goal.
Of course, there are many options outside of a traditional mortgage refinance, including cash-out refinances. The best way to explore all of the options that are available to you is to connect with reputable lenders.
Equity and Refinancing
We've come to the big question that homeowners want to know: "Will I lose equity if I refinance?" The answer? It depends. Let's dive deeper.
If you opt for a conventional refinance and your home value has neither decreased nor increased, and you're simply securing a lower interest rate, your equity would stay the same. Remember, equity is the value of the home minus your mortgage balance. If those numbers aren't changing, your equity won't either.
If there are closing costs to consider and you have the option of rolling those costs into your new loan, then you're increasing your loan amount and, thus, are reducing your equity. However, that decrease usually isn't anything substantial, perhaps a couple of thousand dollars. Most borrowers appreciate avoiding out-of-pocket costs for refinancing and happily take a slight hit in equity.
It's important to keep an eye on private mortgage insurance when refinancing. If your equity drops below 20%, for example, a lender may require you to obtain PMI. If that's the case and you were to use your equity for closing costs and that move drops your equity below 20%, you'd be doing yourself a disservice.
Of course, if you choose a cash-out refinance then yes, your home equity will drop as you're tapping into your equity. As you can see, there are many things to be aware of when protecting or using your equity while refinancing. The good news is that it isn't as complicated as it may seem!
A reputable lender can account for your refinancing goal and the equity you want to protect before making recommendations on which refi option is best suited for you. It's always best to compare lenders so that you can be confident the course of action you're leaning towards is the right move for you.
There's great news for borrowers looking to protect their equity while securing lower monthly installments. Interest rates are at historic lows! Even a 1% drop in interest has the potential to save thousands of dollars over the life of a loan. Can you afford to miss out on that kind of savings?
When it comes to refinancing, time is of the essence. Rates are not expected to hold at these lows for long, which means by waiting just a few weeks to explore your specific offers, you could lose out on significant savings.
With help from Lendgo, a free, unbiased platform that helps borrowers connect with lenders, it's easy to learn more about the market and chat with providers who are eager to work with you. Protect your financial health by shopping for refi lenders now!