So here’s a common scenario: You bought your house several years ago, back when interest rates were higher. Then economic factors have changed, which has caused interest rates to start falling. In fact, by refinancing your home, you can reduce your interest by more than a percentage point, saving you money on interest and lowering your monthly mortgage payments. But what happens to your equity when refinancing your home? That is another important factor you should know a little about before starting the refinancing process.
What Is Equity?
Equity represents the portion of your home that you own. When you first purchased the home, the equity was the home’s market value minus your down payment. Generally, the purchase price of your home is roughly the same as its market value.
As you pay down the principal of the mortgage amount of your home, you’re increasing your equity. The market value of your home also changes over time. So your home’s value might have increased or decreased. To determine the current equity on your home, take your home’s current market value and subtract the total home loan amount that you have left. For example, if your home’s current value is $400,000 and you have $250,000 remaining on your home loan, then you have $150,000 in equity.
Equity And Refinancing A Home
Having enough equity on your home is important because it determines whether you are eligible to refinance your home loan. Your equity is used to determine your loan-to-value ratio, or LTV. The calculation for LTV is the amount that you have remaining on your home loan divided by your home’s current value.
So, in the example above, that would be $250,000 divided by $400,000, which is equal to 62.5 percent. Refinance lenders have different requirements for the LTV you must have on your home that are based on the type of refinance loan you want.
Potential To Increase Or Decrease
Whether your home’s equity has increased or decreased is determined by a number of different factors. Some of these factors include the school zone of your home, crime rates, home values in your area, and how close public safety services like a fire station are. If you’ve added a new addition, such as a bedroom, finished the basement, or a new covered patio, that could also affect your home’s market value. Unemployment levels, interest rates, and other economic factors also play into how much your home is worth.
Current Market Value Of A Home
To get the most accurate estimate of what your home is worth, you need an appraisal completed. This is part of the process when you submit a home loan application. Lenders want to know how much your home is worth and whether it has increased/decreased in value since your last loan.
They will use that information to determine whether or not to approve, amend, or decline your request. A licensed appraiser will compare similar sized properties near your area that have been sold recently and compare it with your home. Sometimes an appraiser will determine the appraised value of your home by calculating what it would cost to rebuild your home. In either case, the current market value of your home is represented by the home appraisal.
The Type of Refinance Desired
The most popular type of refinance loan is what’s known as the straight refinance. This is the type where you want to take advantage of the lower interest rate to refinance your existing mortgage. When the new balance on your old loan is the same as the old balance, it is what lenders will call a straight refinance.
With this type of refinance, you will build more equity on your home faster. This is because your payments have more going to the principal loan amount because of your lower interest rate. You may find out about price related changes to your equity during the appraisal on your home, which may cause your equity to increase or decrease.
The other type of common refinance process is the cash-out refinance. These loans are used to tap into the equity of your home to pay off other debts or to be used for other financial purposes. For example, if you owe $10,000 in credit cards that have an average interest rate of 25 percent, you might want to access your equity to pay it off because you can get a much lower rate on your cash-out refinance.
Many lenders and mortgages that are backed by the government (Freddie Mac) will allow you to take up to 80 percent of your equity on a cash-out loan. So that means you must have at least 20 percent of your equity remaining after a cash-out refinance.
Reach Out To Mathis Title
Work with Mathis Title to have an experienced refinance expert on your team. We’ll be there to help throughout the refinancing process until you are done with closing and receive the best loan for your needs. Call us today at 703-865-7880 to get started.