Refinancing your mortgage doesn’t have to mean losing home equity. Just the opposite, in fact: The goal of a refi generally is to get a new loan with lower interest rates, making repayments easier and allowing you to build equity faster.
However, refinancing can cause you to lose money in the long run if you are not careful, and the process itself can affect your home’s equity overall. Before deciding to refinance, here’s what to consider to ensure you don’t diminish your hard-earned home equity stake.
Usually, it doesn’t. If your home is appraised at $300,000 and you owe $150,000 on your mortgage, refinancing that mortgage does not change the fact that your home is worth $300,000.
Refinancing doesn’t necessarily have to affect the equity in your home, but in certain cases, it definitely can. Factors that determine the equity in your home include the balance owed on your mortgage and how much your home is worth. The difference between these two figures is your home equity. During the course of refinancing, your mortgage balance can increase in various ways, which decreases your equity.
For example, when refinancing your mortgage, you’ll incur closing costs (just as you did with your original home loan). If you opt to have these upfront expenses rolled into the new mortgage, instead of paying them right away, you’re augmenting the mortgage balance — the amount you owe — and thus diluting your equity — the amount you own.
Similarly, a cash-out refinance can impact your home equity. This type of refi means you are pulling from your equity to receive ready money. To provide you with that cash, the lender increases your loan balance to cover the lump sum payment. And once again, your home equity is diminished.
On the flip side, you can build your equity over time by refinancing to a shorter loan term loan, from a 30-mortgage to a 15-year mortgage. “With a shorter repayment period, you’ll pay off the principal balance more quickly, increasing your ownership stake in the home,” says Linda Bell, senior writer on Bankrate’s Home Lending team.
There are two ways that you can refinance your mortgage: a straight refinance or a cash-out refinance.
Straight refi: A straight refinance (aka a rate-and-term refinance) is when you borrow exactly the same amount you owe on your current mortgage. Refinancing allows you to obtain lower interest rates compared to your old loan, paying off more of the principal balance each time you make a payment. The more quickly you are able to pay off your loan, the more quickly you build up your home’s equity. Therefore, a straight refinance could help you increase your home’s equity in the long run.
Cash-out refi: By contrast, a cash-out refinance mortgage is a lot riskier and could dramatically diminish your home equity. The extra amount you borrow comes from your ownership stake, using it as collateral for the lump sum. In other words, you are turning some of your equity back into debt.
While you can use the cash from the refi for a variety of purposes, it’s generally best for home improvement projects, repairs or anything else that will put value back into your home, and replenish the worth of your ownership stake. Otherwise, you have substantially diluted it, and only years of mortgage repayments — and/or a big rise in real estate values — will build it up again.
Refinancing can impact your home’s equity for better or for worse. It is important to consider lender fees and closing costs, in addition to having a clear understanding of the current value of your home. Here are some of the main ways that refinancing can impact your home’s equity.
Lenders conduct an appraisal when you submit a loan application, which is why you should have a sense of the current market value of your home. Your home could have increased or decreased in value since your last appraisal. The amount that the home now appraises for impacts the size of your new mortgage, the value of your equity stake, and — if you’re doing a cash-out refi — how much cash you can actually receive.
Appraisers will consider basic features about your property — age, square footage, number of rooms — along with neighborhood factors such as crime rates, school zones and proximity to local fire stations. The appraisal will also compare your home with similarly sized properties that have recently sold. If you over- or underestimate your home’s value when deciding how much you want to refinance, you could risk losing money or missing out on lower interest rates.
Calculations of your home equity stake begin with the overall value of your property. The real estate market can be variable and your home’s worth can increase and decrease based on its fluctuations. If your home’s value varies, the value of your home equity stake will too. You should always consider market forecasts and trends and how your home’s value will be affected before taking out any additional home loans.
If you decide you do not want to pay closing costs immediately, many lenders allow you to roll these costs into your refinance loan. For example, if closing costs on your refinancing are $5,000 and the amount you are refinancing is $150,000, the lender can give you a total of $155,000, borrowing against your home’s value and reducing your equity by $5,000.
Just like getting any other loan, rates and costs of refinance loans can vary by lender. It’s a good idea to talk with multiple lenders before deciding to refinance. This can give you a better idea of the typical cost to refinance and help you find the best deal.
“Before shopping around for lenders, make sure you crunch the numbers using a mortgage refinance calculator,” says Bell. “That can give you an idea of how much you will save or lose by refinancing. Your goal might be to secure a lower interest rate and monthly payment. While numbers may initially be appealing, if you plan on moving within the next few years, the immediate savings may not outweigh the costs of the loan.”
Your home’s equity remains intact when you refinance your mortgage with a new loan, but you should be wary of fluctuating home equity values, which reflect residential real estate prices and property values in general. The last few years, in particular, have been a ride.
For example, the pandemic-fueled price rise in homes caused home equity stakes to skyrocket, hitting a record high in the third quarter of 2021. Then, as the rise in interest rates began to dampen the housing market in mid-2022, home equity growth slowed and actually declined year-over-year in Q1 2023 — for the first time since 2012.
However, by Q3 2023, the housing market began to recover, and the value of home equity stakes was back up. Data from property analyst CoreLogic shows that U.S. homeowners with mortgages have seen their equity increase by a total of $1.5 trillion as of the first quarter of 2024. That’s an increase of 9.6 percent year over year.
Source: ICE Mortgage Technology
Several social and economic factors impact property values and by extension, your home’s equity, including unemployment levels, interest rates, crime rates and rezoning in your area. Historically, real estate has appreciated over the long term, but it can move slowly and inconsistently. Values can also vary quite a lot between regions.
Whatever the state of the housing market, it’s important to get a strong sense of how much equity you have in your home before refinancing or taking out any loans against your home’s value. Otherwise, you could end up paying too much to refinance your mortgage, or missing out on savings opportunities if you underestimate — or falling short of your needs if you overestimate.
To refinance a conventional mortgage, you typically need at least 20 percent equity in your home. This means your current mortgage balance should be no more than 80 percent of your home’s appraised value, technically known an 80 percent loan-to-value (LTV) ratio.
However, government-backed loans like FHA, VA, and USDA may have different requirements. FHA streamline refinances and VA loans might not require an appraisal, allowing refinancing with little or negative equity.
“If you aren’t sure how much equity you have or which refinancing option is best for you, reach out to a mortgage professional,” says Bell. “They can give you personalized advice and help you make the best choice for your home and wallet.”
Refinancing isn’t the only option you have when you want to access your home equity. So what are the differences between a home equity loan and a cash-out refinance?
Both mean you are putting up your home as collateral for debt. But a cash-out refinance involves a new mortgage. It’s a way to take advantage of a drop in interest rates — if they are trending lower than when you took out your first loan — and possibly change your loan term as well. It can be a good option if you just want to have one monthly payment or to save money on interest over time.
A home equity loan, often dubbed “a second mortgage,” is a whole different animal. Getting a home equity loan means you keep your original mortgage, and are taking on a new debt — the size of which is based on your home equity. This means you have to manage two monthly payments. Still, it can be a good option if you want to keep the current interest rate you have on your mortgage.
It is still possible to take a home equity loan after refinancing, but in order to qualify, you will need to have a certain amount of equity built up in your home. Lender approval is based on the percentage of equity you have in the house and typically the requirement is 15 to 20 percent.
If refinancing your home diminishes the amount of equity you have available below this amount, you may have to wait to take out a home equity loan until you pay the balance of your mortgage down further. Most home equity loan borrowers are at least one-third of the way through their mortgage terms, and have a substantial ownership stake built up.
While refinancing does not initially impact your home equity, some factors could negatively or positively affect your home’s value over time. It is also important to remember that the worth of your ownership stake is merely on paper, unrealized until you actually sell your home and receive cash for it. Until then, your equity position over time will vary depending on home prices in your market and loan balances on mortgages.
Before deciding if and for how much you would like to refinance, make sure you are up-to-date on your home’s current appraisal value. Compare mortgage refinance rates and APRs, which reflect lender fees and closing costs. That way, you can make the sort of move that ensures you’re a winner, not a loser, in the home equity stakes.
