HOW MUCH EQUITY DO YOU NEED FOR A MORTGAGE REFINANCE?

Vault’s Viewpoint on Equity For A Mortgage Refinance

• Most loan programs require at least 20% equity to refinance. 
• Very few options exist to refi without equity, although homeowners with FHA, USDA or VA loans may have a path forward. 
• Refinancing can allow homeowners to change the terms of their loan or cash out some of their equity. 

Understanding the State of Home Equity in 2024

To give you a better idea of home value growth in the last couple of years alone, we can look to data from the National Association of Realtors (NAR). They report that the median sales price of existing single-family homes in metropolitan areas jumped from $357,100 in 2021 to $394,600 in 2023. That means that without doing anything, many homeowners saw a nearly $40,000 increase in their equity. 

While home values have seen a particularly hot streak of growth in the last few years, this trend is by no means an outlier. Data from the Federal Reserve Economic Data (FRED) shows that home prices have climbed fairly steadily since 2012. And other than a downturn tied to the Great Recession, the home price index has trended upward since the late 1980s.

In other words, homeowners are likely to see equity grow in two ways. The first is tied to home value growth in your local market. As values grow, your equity does too. 

The second form of equity growth comes through paying off your mortgage. As the balance of that loan shrinks, the portion of your home that you own outright grows accordingly. 

All told, many homeowners are currently sitting on a big chunk of equity. If you’re among them, that can open up some opportunities. So can you use equity to refinance? And if so, how much equity do you need to refinance—and how will the refi benefit you?

How Much Equity To Refinance

First up, we should clarify something about refinancing. A mortgage refinance doesn’t modify your existing home loan. Instead, a refi means you take out an entirely new loan. All or some of those loan proceeds (depending on the type of refi) go to pay off your previous mortgage in its entirety. You then move forward with the new refinanced mortgage in place.

You can refinance with your current lender, but you can also explore refinancing with other mortgage lenders. 

Because refinancing means getting an entirely new mortgage, it comes with underwriting standards that are just as rigorous as when you initiated your first mortgage. Lenders still use your home as collateral to secure the new loan, so they want to see that you own a good chunk of it outright. That brings in the equity piece. 

So how much equity do you need to refinance? It depends, but there’s a commonly used benchmark. 

The General Rule: 20%

In most loan scenarios, lenders want to see at least 20% equity when undertaking a refinance. This mirrors the historic 20% requirement for a down payment.

To find out if you hit that 20% mark, you can calculate your equity with the following steps:

1. Figure out your home’s current value (real estate websites like Zillow and Redfin offer estimates based on your address).
2. Subtract the amount remaining on your mortgage from the current value.
3. Divide the result by the current value.
4. Convert that decimal to a percentage by multiplying it by 100. 

Say, for example, your home is currently valued at $450,000 and you have $325,000 remaining on your mortgage:

$450,000 – $325,000 = $125,000. 

That gives you $125,000 of equity, which is 0.28 of $450,000 ($125,000 / $450,000 = 0.28 [rounded]). You have 28% equity (0.28 * 100 = 28%), which is plenty to refinance. 

Refinancing With Less Equity

In the same way that most homebuyers don’t put 20% down, lenders may be willing to explore a refinance with you if you have less equity. With a smaller chunk of your home to stake as collateral, though, you’ll need other ways to show them that you’re a low-risk borrower. 

Usually, that means having a good credit score and a sufficient amount of income to comfortably cover your new mortgage payment. You can ask lenders about their requirements in terms of how much equity to refinance with them, along with other requirements. 

If your borrower profile isn’t stellar and you have less than 20% equity, you have one more option. Look into loans backed by the Federal Housing Administration (FHA), which are available through lenders across the country. 

Specifically, look for lenders who offer an FHA cash-out refi. This is available to current FHA borrowers, but it’s also an option if you have a conventional (non-government-backed) type of mortgage. 

If your new mortgage amount will be less than $417,000, you can refinance with a loan-to-value (LTV) ratio of just 95%, meaning you only need 5% equity. If you’re over that limit, you can still refi with an LTV of up to 85%, which would mean you need 15% equity or more. 

A Refi Without Equity

If you don’t have any equity at all but you have a loan backed by a government agency, you might be in luck.

With an FHA-backed loan, you can explore an FHA streamline refinance, which doesn’t have an equity requirement. 

If you have a VA loan, which is guaranteed by the Department of Veterans Affairs, you’re allowed to refinance with an LTV of up to 100%. That means you can be at 0% equity (but not underwater). This is an option with both cash-out VA refinances and interest rate reduction refinance loans (IRRRLs). 

Similarly, the United States Department of Agriculture (USDA) offers Streamlined Assist Refinance Loans, which let homeowners refinance with no equity. 

That said, offering a refi without equity is fairly high-risk for lenders, so many still require an LTV of at least 90%. 

Reasons To Refinance

Can you use equity to refinance? Absolutely. But should you? It depends on your situation. Refinancing usually means paying closing costs, which Freddie Mac (a federal home loan company) reports average at roughly $5,000. 

Here are a few reasons you might want to explore the refinance and hand over that chunk of change. 

Pulling Cash Out

As homeowners have watched their equity grow, many don’t want to just sit on that value. With a cash-out refinance, you can turn some of your equity into cash. And you can use that cash however you want.

Lowering Your Interest Rate

While this probably isn’t applicable in our current high interest rate environment, securing a lower interest rate is an excellent reason to refinance. 

If rates come down below your current mortgage interest rate, refinancing into a loan at that lower rate can save you a significant chunk of money over the life of your loan. 

Swapping Your Loan Term

The interest rate isn’t the only thing you can change with a refi. You can also change your loan term (the expected length of time you have to pay it off). 

If money’s tight, you might ask your lender how much equity to refinance into a new 30-year loan. Resetting the timeline on your loan means paying less each month.

Alternatively, if you just got a raise, you might refi into a loan with a shorter term. Fifteen-year loans generally have lower interest rates than 30-year ones. 

Converting an ARM to a Fixed-Rate Loan

Adjustable-rate mortgages (ARMs) mean a certain level of unpredictability because your lender can adjust your interest rate periodically. If you’d rather have your housing costs be a known quantity, you can refinance an ARM into a fixed-rate mortgage. 

Getting Rid of Private Mortgage Insurance

Some people refinance to eliminate private mortgage insurance (PMI), which is insurance that lenders often require if you put less than 20% down. 

That said, if you have a conventional mortgage, you don’t need to refinance to have PMI removed. Once you reach 20% equity, you can request removal from your lender. 

Other Requirements To Refinance Your Mortgage

If one of the above reasons struck a chord with you, you should know that equity isn’t the only thing lenders check before agreeing to a new home loan. You’ll generally also need to satisfy the following requirements to refinance:

• Waiting periods: Some lenders have a waiting period built in before you can refinance, even if you have sufficient equity. And government-backed loans often come with a waiting period too. If you want to refi an FHA loan, for example, you’ll need to wait six months first. 
• Credit score: The minimum credit score you’ll need varies from lender to lender, but most lenders like to see a score of at least 620.
• Debt-to-income (DTI) ratio: To ensure too much of your monthly income isn’t going to your mortgage, lenders evaluate your debt-to-income ratio. If your DTI ratio is less than 36%, you’ll usually be in good shape for a refi. 

The post How Much Equity Do You Need For A Mortgage Refinance? first appeared on Newsweek Vault.

2024-05-06T16:55:25Z dg43tfdfdgfd