Refinancing your mortgage can open up new possibilities. You can score a lower monthly payment, get a better interest rate, or tap into your home equity with a cash-out refinance.
While the perks may sound nice, you need enough equity in your home for the refinance to go through. Mortgage lenders aren’t going to let you borrow more than what your home is worth. However, most lenders have limits that cap out well before you borrow your home’s entire value.
This guide will explore how much equity you need to refinance your home and strategies to build your equity.
Understanding Equity in Your Home
Home equity is the percentage of a property that you own outright. Homeowners build equity with each monthly mortgage payment. It’s also possible for your home equity to rise if your property’s value goes up.
Building home equity will get you closer to paying off your mortgage and being debt-free on your property. You can also borrow money against the value of your home, which is equal to your equity. Consumers can choose to access additional cash via home equity loans or home equity lines of credit. A higher credit score will give you more options.
Lenders have some guardrails that limit how much equity you can access with a home loan, but it’s possible to borrow the majority of your available equity. The more equity you have in your home, the more capital you can borrow if necessary.
How to Calculate Your Home Equity
You can calculate home equity by subtracting a property’s mortgage balance(s) from its value. If a homeowner has a $1 million home and a $600,000 mortgage, that homeowner has $400,000 in equity.
The Benefits of Refinancing
Refinancing can offer several benefits for homeowners. You may not get all of these advantages at the same time, but these are some of the perks that you can prioritize:
- Lower monthly payments by extending the loan term
- Lower interest rates if your current mortgage has a high rate
- Tap into additional equity with a cash-out refinance
- Get out of debt sooner with a shorter mortgage term
Why is Home Equity Important When Refinancing?
Every mortgage lender will look at your home equity before letting you refinance your mortgage. Having more equity will give you more choices, and it will let you access additional funds through a cash-out refinance.
Mortgage lenders set limits on how much you can borrow. This limit is quantified as the loan-to-value ratio (LTV). This ratio measures your total mortgage balance(s) against your home’s value. If you have a $1 million home and $800,000 in total mortgage balance(s), you have an 80% LTV ratio.
Most lenders will not let you exceed an 80% LTV ratio for a refinance. Some lenders and types of loans offer more flexibility.
What Happens If You Don’t Have Enough Equity to Refinance?
Not having enough equity can make it more difficult to refinance. You can also end up having to wait until you have built enough equity to request a refinance.
The Impact of Low Equity on Refinancing
You will have fewer options. Some lenders have higher LTV ratio ceilings, but those loans usually come with higher mortgage rates and fees. Lenders take on more risk when they do business with borrowers who have high LTV ratios.
How Much Equity Do You Need to Refinance?
The amount of equity you need to refinance depends on the type of loan you seek. These are some guidelines to keep in mind.
Refinancing with a Standard Loan
Freddie Mac and Fannie Mae outline the maximum loan-to-value ratio you can have for a refinance. The maximum value depends on the type of property you own. These are the maximum LTV ratios for conventional loans depending on the type of property:
- Single-family: 95% LTV ratio
- 2-unit primary residence: 85% LTV ratio
- 3-4 unit primary residence: 80% LTV ratio
- Second home: 90% LTV ratio
- 1-unit investment property: 85% LTV ratio
- 2-4 unit investment property: 75% LTV ratio
Refinancing with FHA & VA Loans
You will need an 85% LTV ratio or lower to refinance your FHA loan. VA loans can have 100% LTV ratios and still qualify for refinancing. However, most mortgage lenders set 90% LTV ratio limits for VA refinancing.
Refinancing with Cash-Out
The same LTV ratios apply but also factor in how much equity you want to take out. For instance, you can end up with a 95% LTV ratio for a single-family primary residence. However, if you already have a 70% LTV ratio, you can only tap into enough equity to raise the total to a 95% LTV ratio. Furthermore, some mortgage lenders will not let you have a 95% LTV ratio. These are only the maximums, and some mortgage lenders are more strict about how much equity you can access.
Tips for Increasing Your Home Equity
Building home equity can enhance your net worth and allow you to take out bigger loans. These are some of the strategies you can use to increase your home equity.
Get a New Home Valuation
Real estate tends to appreciate over time due to its viability and limited supply. Getting a new home appraisal can unlock new equity in your home. You may have to get a home appraisal to fulfill a mortgage lender’s requirements. Knowing the current value of your home will give you a better perspective of where you stand with your home equity.
Home Improvement Ideas
You don’t have to wait for your home to gain value. Some homeowners take matters into their own hands and opt to improve their homes. Updating key rooms like the kitchen and bathroom can enhance value, but you can also work on other rooms or the outside of your home. Homeowners have many ways to improve the quality and value of their homes. However, it’s important to weigh the costs of home improvement against the potential upside.
Making Additional Mortgage Payments
Making an extra mortgage payment each month will help you build more equity in your home. The additional monthly payments can also minimize the total interest you pay over the life of the loan. While you can tap into this equity through a refinance, some people make extra payments just to get out of debt faster. Some homeowners do not intend to borrow against their home equity when they make additional monthly mortgage payments.
Eliminate Mortgage Insurance
Mortgage lenders require mortgage insurance if you have less than 20% equity in your home. The premiums for the policy can add an extra $1,000/yr to your total expenses. Homes with higher valuations can end up with higher monthly private mortgage insurance premiums.
Getting to the 20% equity threshold sooner can rid you of private mortgage insurance and give you more room in your budget. You can also continue to make the additional monthly payment but put it toward your principal instead of a private mortgage insurance company.
Next Steps After Understanding the Equity Needed to Refinance
After you review your equity and know how much you can access, the next step is to decide if a refinance is right for you. Consumers should assess their financial situations and determine how a refinance would move them closer to short-term and long-term goals.
Then, you will have to compare rates and terms from multiple mortgage lenders before accepting the optimal offer. While you may find a great deal with your current lender, it’s also possible that you will find a better offer if you reach out to several lenders.
Refinancing your mortgage and tapping into your home equity can be a great move. It’s one of the perks of being a homeowner. You have more flexibility, but borrowers should weigh the pros and cons before making a decision.
Frequently Asked Questions About Home Equity and Refinancing
It’s possible to refinance with 10% equity, depending on the type of property you have and the type of loan you seek. However, not every mortgage lender will work with borrowers who have low equity.
Refinancing with less equity can result in higher interest rates since less equity increases the lender’s risk.
You should consider how a refinance will impact you immediately, as well as the long-term impact of refinancing your current mortgage. It’s important to consider how your budget will change and how you will use the extra funds if you want a cash-out refinance.
