How Much Equity is Needed to Refinance?
When you’re considering refinancing your current mortgage, the two factors you’ll need to understand first are equity and LTV – otherwise known as loan-to-value ratio. They’re really two sides of the same coin, so let’s break it down. How much equity is needed to refinance?
The combination of making payments and increasing value is what creates equity in your home. Simply put, the property value minus your outstanding loan amount equals equity. If your home is worth $400,000 and you still owe $300,000, then the equity is $100,000 – or 25%.
The LTV ratio is the inverse, and it’s an important metric that lenders will look at to determine refinancing eligibility. Ideally, they prefer an LTV ratio of 80% or below, which indicates a lower level of risk for them. The example above would be 75% LTV.
How Much Equity Do You Need?
While the rule of thumb for your home is 20% equity needed to refinance, there are different limits, depending on the mortgage lender and the type of loan. Lenders will also look at credit rating, payment history and other circumstances for equity below 20%, or they may charge a higher interest rate.
When you begin the refinance process, the lender will arrange an appraisal to determine your home’s value, and accordingly, the equity. Any improvements since you purchased, or major repairs that may be needed will factor into the appraised value. You can be proactive and check out the comparative home sales in your neighborhood to get a general idea of your home’s value, then us a loan-to-value calculator to determine the ratio.
Although 20% equity is your objective in order to snag the best interest rates, you still may be able to qualify with less equity. When your credit rating and payment history is good, you could still be eligible for conventional financing with a higher interest rate and/or by acquiring private mortgage insurance (PMI).
Mortgage insurance protects the lender in case of defaulting on the loan; it’s typically 0.5-1% of the home’s value and can be rolled into the monthly mortgage payment. When you reach 20% equity or you refinance again, you can eliminate the PMI in the future.
Loans insured by the Federal Housing Administration (FHA) are terrific for borrowers in circumstances that would otherwise make them ineligible to refinance. Whether you’re working with a higher LTV or a lower credit score, FHA borrowers have more flexibility. Rates are still competitive, but insurance will be required – which is called mortgage insurance premiums (MIP) for Federal loans.
If you have an existing FHA loan, then refinancing into another government-backed program is possible with a streamlined FHA – even with an LTV over 100%. Some stipulations apply, such as the loan must be current, cash-out amounts can’t exceed $500, and closing costs can’t be rolled into the loan. Another benefit of streamlining is eliminating the need for an appraisal. Other FHA refinance programs do allow cash-out as high as 85% of home’s value, but you’ll want to check with individual lenders for more details.
The Veterans Administration (VA) makes owning and refinancing a home much simpler for our nation’s past and active military members. Qualified borrowers can refinance up to 100% of their primary residence’s value, although there is a cap on how much liability the VA will assume. The VA offers a streamline program as well, called the Interest Rate Reduction Refinance Loan, or IRRRL.
The benefits of the IRRRL include no mortgage insurance required, and no appraisal or credit underwriting needed upon application. However, you can’t receive a cash-out on an IRRRL or use proceeds from the refinance to pay other loans.
As you can see, the questions of how much equity is needed to refinance, or what the best LTV is to qualify for refinancing offer several answers. Interest rates and home values are on the move, so if you’d like to discuss your home’s potential equity and your qualifications for refinancing, EnTrust Funding (ETF) is happy to help. Contact us today for a conversation on your objectives and options!