You want to refinance your mortgage, but you aren’t sure if you have enough equity. What’s the average amount that lenders require?
The general rule of thumb is you must have 20% equity in your home to refinance. But, there are ways around this. While it makes the most sense to wait until you have the illustrious 20% in home equity because you’ll avoid PMI, almost every loan program has the option to refinance with less than this amount.
Refinancing With Conventional Loans
Conventional loans typically require at least 5% equity in your home before you can refinance. Does it make sense to do so, though? That’s what’s up for debate.
What are your reasons for refinancing? Are you trying to save money on your monthly payment? You may want to wait until your home appreciates enough and you pay the principal balance down more to get to that 20% equity point. At this point, you won’t pay PMI, which in and of itself will result in savings. If you combine those savings with a lower interest rate, you stand to save a significant amount of money on your mortgage payment. This could make refinancing worth it, since it will cost you money to refinance. You want to get the most for your money.
What happens if you refinance with less than 20% of equity in your home? The conventional lender will likely charge you a higher interest rate and/or higher fees. Borrowers with at least 20% equity in their home are seen as ‘less risky’ than those that have less than 20% equity in their home. If you don’t have at least 20% equity in your home and you want to refinance, make sure you shop around for the best deal.
If you want to refinance and take cash out of the property, though, you may only borrow up to 80% of the home’s value. This leaves 20% equity in the home. Should you default, the lender may have an easier time selling the home and recouping their investment in the loan that you defaulted on.
Refinancing With FHA Loans
FHA loans only require 3.5% equity in your home to refinance. In this case, it doesn’t matter if you have 20% invested or not. FHA loans always charge mortgage insurance. In fact, they charge it for the life of the loan. You don’t have the option to eliminate the insurance once you owe less than 20% on the home.
The FHA does offer the opportunity for a streamline refinance. If your goal is to lower your monthly payment or shorten the term of your loan, this is a great program. All the FHA requires is proof of timely mortgage payments for the last 12 months and proof of some type of benefit for the refinance – that’s it!
Now, if you want to tap into your home’s equity, you may only borrow up to 85% of the home’s value. This leaves you with 15% equity in the home. The FHA does this to protect their investment. Cash-out refinances are often riskier than rate/term refinances since you take out a larger loan. The lender is at higher risk of default, so the FHA wants a higher amount of equity to remain in the home to protect the lender.
Refinancing With VA Loans
VA loans are another exception to the rule. Technically, you don’t need equity in your home to refinance your VA loan. They provide 100% financing. This even applies to cash-out refinances. You may borrow up to 100% of the home’s value with a VA loan.
VA loans don’t charge monthly mortgage insurance, so you don’t have to worry about your LTV in that respect. They do charge a funding fee every time you refinance, though. If you use the VA streamline option, which only requires you to prove that you paid your mortgage on time for 12 months and that there’s a benefit for the refinance, you will only pay 0.5% of the loan amount in a funding fee. Any other refinance may cost as much as 2.15% of the loan amount.
As we stated above, you can even borrow up to 100% of the home’s equity with a cash-out refinance. You’ll have to decide if it’s in your best interest to do so, though. If you borrow 100% of the equity, you’ll start over again, building up equity in your home. If you plan to stay in the home for the long-term, it may make sense, especially if you are using the funds to improve your home. If you plan to move soon, though, you may walk away with very little profit and little money to invest in the next home if you plan to buy another home.
How much equity you need in a home to refinance depends on the program. You are better off having a decent amount of equity in your home when you refinance just to keep the interest rates and closing fees low. If you don’t, though, there are options available, giving you the opportunity to refinance and reach your financial goals.