Homeowners may think they need lot of equity in their home to refinance, but that's really not the case at all.
How Much Equity Do You Need To Refinance?
Imagine saving thousands of dollars over the life of your loan by simply taking a new loan with a lower interest rate. Well, that’s exactly what refinancing can do for you. Besides lowering your monthly mortgage payments, mortgage refinancing allows you to change your loan term or shift from an adjustable-rate mortgage to a fixed-rate loan.
The hurdle, however, is qualifying for a refinance. Besides reviewing your credit score, income and debt-to-income ratio (DTI), lenders check on your equity stake before approving a refinance. Let’s answer some of the most frequently asked questions (faqs) on equity requirements when refinancing.
How do I calculate home equity and loan-to-value ratio?
Home equity is the portion of a property’s value that a homeowner owns outright, calculated as the appraised value of your property minus the current mortgage balance and any other loans secured by the property such as home equity loans or home equity lines of credit (HELOCs).
For example, if the current appraised value of your home is $300,000 with an existing mortgage balance of $200,000, your home equity would be $100,000. Your loan-to-value ratio(LTV) is the loan balance divided by the appraised home value. In this case, your LTV would be roughly 67%.
Can I refinance with 10% home equity?
Many homeowners think they need a big chunk of equity to refinance. But in fact, it's possible to refinance with very little equity or even none at all.
How much equity you'll need depends on a number of factors, says Michelle Velez, sales manager at W.J. Bradley, a mortgage company in San Mateo, California.
"It's a complicated answer," Velez says. "There are a lot of different things to mull around."
Two of those factors are:
The type of loan you have and the type you’re looking to refinance to, and
The purpose of your refinance.
For instance, if you’re looking to refinance to a conventional mortgage you only need 5% equity. However, you’ll likely get a higher interest rate and an added cost of mortgage insurance.
Government-backed refinance loans like the FHA and VA streamline refinances may allow you to refinance with less equity and are good options if you have bad credit.
Each loan type -- conventional, FHA, Jumbo or VA -- has different equity requirements. Here is a breakdown of each of these refinancing options:
How much equity do I need to refinance a conventional loan?
Conventional wisdom says you'll need a minimum credit score of 620 and 20% equity to refinance with a conventional loan, but in fact, you'll only need 20 percent if you want to avoid private mortgage insurance or plan to do a cash-out refinance.
Mortgage insurance protects the lender in case you default on your monthly payments. With mortgage insurance, you can refinance with as little as 5 percent equity, says David Krichmar, mortgage banker at CORE Lending in Conroe, Texas.
If you're pulling cash out, "you pretty much have to be at 80 percent loan-to-value," Velez says. In other words, cash-out refinancing requires at least 20% equity.
How much equity do I need to refinance a jumbo loan?
A conventional loan that exceeds the Fannie Mae and Freddie Mac conforming loan limit is known as a jumbo loan. Lenders set their own guidelines for these non-conforming loans, so you'll have to shop around to find out the amount of equity you'll need to refinance.
In the current market, a 20% to 30% equity stake is likely required, but underwriting guidelines can vary from lender to lender and market to market.
How much equity do I need to refinance an FHA loan?
FHA mortgages, insured by the Federal Housing Administration, allow refinancing homeowners to push the equity envelope.
The FHA offers the FHA streamline refinance for loans it already insures. No home appraisal is required, so homeowners can refinance with very little equity, no equity, or even negative equity.
"Even if you owe twice what your home is now worth, the FHA will refinance your home without added cost or penalty," the agency's website explains.
For streamline refinances, your loan must be current, no cash-out is allowed, and closing costs cannot be added to your loan amount. For a standard FHA refinance, "you can pull cash out on an FHA loan to 80 percent," Velez says. "So you could have a loan amount that's 80 percent of the home's value." The former limit was 85%, but this FHA LTV requirement changed in August 2019.
All FHA loans require that you pay mortgage insurance premiums. FHA-backed loans with original loan-to-value ratios above 90% carry premiums for the life of the loan, and loans with less than an original 90% LTV have MI premiums for at least 11 years. If you can qualify for a conventional loan (where MI may be able to be canceled sooner) or have at least 20 percent equity, you might not want to refinance into an FHA loan.
However, since FHA does not use risk-based pricing, borrowers with lower credit scores can get the same rock-bottom mortgage rates as someone with great credit, and it might be worth refinancing into the program if the benefits of a new lower rate also cover any mandatory mortgage insurance costs. You can compare FHA loan costs versus conventional loans with PMI.
How much equity do I need to refinance a VA loan?
The U.S. Department of Veterans Affairs (VA) also offers a streamline refinance known as the VA Interest Rate Reduction Refinance Loan (IRRRL). According to the VA website, you must have an existing VA loan and refinance into a new VA loan to use this program.
No appraisal is required, and you can add your closing costs and VA funding fee to the loan amount, but you can't take cash out. (The funding fee can be waived in some cases).
If you've moved out of your VA-financed home, you'll need to certify that you occupied the home as your residence at one time.
How much equity can you take out on a refinance?
The amount of equity you can take out depends on the value of your home, your loan type and the lender's guidelines. Generally, you can take out up to 80% of your property value, less your mortgage balance. To put it differently, lenders usually require that you maintain at least a 20% equity stake after refinancing.
However, some lenders may offer higher loan-to-value ratios for certain types of properties or borrowers. For instance some VA lenders allow veterans to borrow up to 100% of the value of their home.
Can I add closing costs to my refinance loan amount?
Closing costs generally can be paid upfront or financed through a slightly higher interest rate or larger loan amount.
You'll need more equity if you add your closing costs to your new loan.
George Thoma, a loan officer at Mann Mortgage in Reno, Nevada, recommends 23 percent to avoid mortgage insurance, too.
"I'm not saying the closing costs will be 3 percent," he says. "I'm saying have a little cushion."
Can I bring cash to closing to increase my equity?
If you don't have enough equity to refinance into the loan you want, you can beef up your stake by bringing cash to the transaction. This is called a "cash-in refinance".
"If it makes sense for you financially, you can easily do that," Krichmar says. "There would be no rule against doing that."
At what point is it worth refinancing?
While a refi can save you money on monthly payments and overall interest costs, it might not always be the right move. A refinance may be worth if:
Current interest rates are at least 1% lower than when you first took out your mortgage;
You plan to stay in the home for the foreseeable future and extending the loan term will bring lower payments;
Your credit score has significantly improved, and you’ve built enough home equity;
Potential savings from your new mortgage outweigh the cost of refinancing;
You want to change the term of your loan, or change the loan product.
You can help determine if a refinance is right for your situation by using HSH’s "Should I refinance my mortgage?" calculator.
(Image: Karen Roach/iStock). This article was edited by Keith Gumbinger.
