Do I Lose Home Equity if I Refinance?
Refinancing your home can be a strategic financial decision, offering the potential for a lower interest rate, saving money, or even accessing cash for urgent needs. However, it's important to understand how refinancing might impact your hard-earned home equity.
By understanding the link between equity and refinancing, you can make smart choices that match your financial goals.
In this article, we'll answer the question, “If I refinance my house what happens?”, and break down different types of refinances to show what they mean for your financial well-being.
If you want to protect your equity and explore refinancing options, you’re in the right place. And if you're ready to start the refinancing process, fill out our Digital Mortgage application now!
Does Refinancing Have Any Impact on the Equity in My Home?
Here’s a clear picture of what happens when you refinance your home:
Is Home Equity Affected by the Type of Refinance I Choose?
The impact of refinancing on your home equity largely depends on the type of refinance you choose.
A rate-and-term refinance means getting a new loan to replace your current mortgage. This new loan should have better terms, like a lower interest rate or a shorter repayment period. Since you’re not borrowing additional funds, your equity remains unchanged.
In fact, by reducing your interest rate or shortenihng your loan term, you could build equity faster as you pay down the principal balance more quickly.
On the other hand, a cash-out refinance does affect your home equity. This type of refinancing allows you to borrow against your home’s equity, effectively turning some of your ownership stake into debt.
For example, if you need extra cash for significant expenses like home improvements or paying for college, you can increase your loan balance by "cashing out" a portion of your equity.
While this can provide immediate funds, it diminishes your equity. The more equity you take out, the less ownership you have in your home. This also means you will have a larger mortgage balance to pay off later.
What Happens to Home Equity When I Refinance?
Here's how refinancing can influence your home equity:
Appraisal and Changing Property Values
When you apply for a refinance, one of the first few steps a lender will take is to conduct an appraisal of your home. An appraisal is a professional assessment of your home’s market value.
The appraised value shows how much you can borrow. If you are doing a cash-out refinance, it also tells you how much equity you can turn into cash. If your home has appreciated since your last appraisal, your equity might have increased.
For example, if your home was worth $400,000 two years ago and you owe $200,000 on your mortgage, you might think you have $200,000 in equity. But if your home’s value has gone up to $450,000, your equity is now $250,000. This gives you more borrowing power if you decide to refinance.
On the other hand, if the value of your home has decreased due to market fluctuations, your equity will also decrease, which could limit your refinancing options.
Closing Costs and Lender Fees
Refinancing isn’t free, and closing costs can significantly impact your home equity. Closing costs are the fees you pay when securing a new mortgage, including application fees, appraisal fees, and more.
If you choose to roll these mortgage loan fees and costs into your new mortgage rather than paying them upfront, your loan balance will increase, thereby reducing your equity. For example, if you refinance a $150,000 mortgage and incur $5,000 in closing costs that you add to the loan, your new mortgage balance would be $155,000. This reduces your equity by the same amount.
The Impact of Market Condition
Lastly, the broader real estate market can influence your equity. In a rising market, your home’s value might increase, boosting your equity even if you refinance. In a declining market, your equity might decrease. This is especially true if you have a larger loan from a cash-out refinance. If property values fall, you could even find yourself underwater, where you owe more on your mortgage than your home is worth.
If you need additional guidance on navigating the market conditions, fill out our Digital Mortgage application and one of our team members will be in touch!
How Much Equity Should I Have in My Home Before Refinancing?
Here’s how much equity lenders prefer to refinance based on the loan type and certain circumstances:
Conventional Loans
For conventional refinances, having 20% equity is ideal. This 20% threshold helps you avoid paying private mortgage insurance (PMI), which protects the lender if you default on your loan.
With 20% equity, your loan-to-value (LTV) ratio is 80%. This means you owe 80% of your home's appraised value. This means your current mortgage balance is 80% or less of your home's appraised value. However, you can still refinance with less equity.
For instance, some conventional loans may allow refinancing with as little as 5% equity. The key is to make sure your new loan terms are good enough to justify the refinance. This is important, even with the extra costs.
Government-Backed Loans
Government-backed loans, such as FHA, VA, and USDA loans, offer more flexibility when it comes to how much equity you need to refinance:
- FHA Loans: With an FHA loan, you might be able to refinance with as little as 5% equity or less. For those looking to streamline their refinance (without taking cash out), FHA loans may not require any equity at all, and even borrowers with negative equity can qualify.
- VA Loans: For VA loans, which are available to veterans and active military members, you can refinance up to 100% of your home’s value with a VA cash-out refinance, meaning you could have little to no equity and still qualify. For those using the VA’s Interest Rate Reduction Refinance Loan (IRRRL), equity requirements are often minimal, making this a viable option even if you have less equity.
- USDA Loans: Like FHA and VA loans, USDA loans offer streamlined refinance options that may not require any equity. This makes them an excellent choice for homeowners in rural areas who might not have a significant amount of equity built up.
How Can I Start the Mortgage Refinance Process?
At Rate, we understand the concerns you may have about refi vs home equity. You don’t have to navigate this process alone. Our expert team is here to guide you every step of the way, ensuring that you make informed decisions that align with your financial goals.
Our Digital Mortgage application makes it easier than ever to start your refinancing journey. It allows you to gain a clear understanding of what happens if you refinance your house, and provides you with an opportunity to lock in favorable rates, and shorten your loan term.
Don’t let worry hold you back. Start your mortgage refinance journey today, and let us help you turn your home into an even greater asset!
Mortgage Refinancing FAQs
1. Does Refinancing Extend the Length of My Loan Term?
Yes, refinancing can extend your loan term if you choose a new loan with a longer repayment period. For example, if you originally had a 30-year mortgage and have 20 years left, refinancing into a new 30-year loan restarts the clock, which may lower your monthly payments but increase the total interest paid over time. Alternatively, you can choose a shorter term, like 15 years, to pay off your mortgage faster and potentially save on interest.
2. Can Refinancing Affect My Credit Score?
Refinancing can temporarily lower your credit score because lenders will perform a hard inquiry on your credit report during the application process. Additionally, if you close your original mortgage and open a new one, this can affect the average age of your credit accounts, which is a factor in your credit score. However, making consistent, on-time payments on your new mortgage can help rebuild your credit over time.
3. Are There Any Tax Implications When Refinancing?
Refinancing can have tax implications, especially if you opt for a cash-out refinance. The interest on your mortgage remains tax-deductible, but the portion of interest that applies to the cash-out amount used for non-home improvements might not be deductible. Additionally, if you refinance and reduce your monthly payments, the smaller interest payments will result in a lower mortgage interest deduction on your taxes.*
4. Can I Refinance If I Have a Second Mortgage or Home Equity Line of Credit (HELOC)?
Yes, you can refinance if you have a second mortgage or HELOC, but it can complicate the process. Lenders might require you to pay off the second mortgage or HELOC, or they may require the second lender to agree to remain in a subordinate position, meaning the first mortgage has priority in case of default. This process is known as "subordination" and may involve additional steps or fees.
5. Is Refinancing Worth It If I Plan to Sell My Home Soon?
If you plan to sell your home in the near future, refinancing might not be cost-effective. The closing costs and fees associated with refinancing may outweigh the benefits if you don't stay in the home long enough to recoup those costs through lower monthly payments or interest savings. Calculating the break-even point—how long it will take for your savings to cover the refinancing costs—can help determine if it's worth pursuing.**
*Rate does not provide tax advice. Contact your tax adviser with any tax related questions.
**By refinancing, you may pay more in costs and interest over the extended term.