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It’s one of the most common questions we are asked when people are refinancing their mortgage loans:
How much does my home equity affect my qualified mortgage rate?
The truth is, your home equity can have a major impact on your mortgage interest rate. Higher equity gives you more borrowing leverage and can be used as collateral toward your new loan. You will be seen as less of a risk by the lender and therefore can qualify for a lower mortgage rate. This is assuming your other qualification standards (credit score, income/employment, and debt-to-income ratio).
What is My Home Equity?
The first and foremost calculation is to figure out your current home equity. This will be based on a current home appraisal. Your lender will hire an unbiased third-party licensed home appraiser to determine the current fair market value of your property. Your home equity is then determined by subtracting your existing loan principal balance from the appraised amount.
If your house appraises for $500,000 and you still owe $350,000 on your original mortgage loan, then your current appraised home equity is $150,000. The higher this equity is in relation to your overall property value, the more it will give you borrowing power when refinancing.
What is My Loan-to-Value Ratio?
Your loan-to-value (LTV) ratio is based on your home’s current appraised value. Your mortgage lender will compare this against your new loan total amount as part of the loan qualification process. The LTV is especially important to understand if you are applying for a cash-out refinance loan and trying to tap into some of your home equity. It is still part of the traditional home refinancing qualification process, though, so you want to know how it works. Having a higher LTV will improve your chances of qualifying for a home loan refinance and getting a lower mortgage rate with your new loan.
How Much Equity Do I Need to Qualify for Refinancing?
For most conventional mortgage refinancing programs, you will need at least 5% of equity in your home. That means it is currently worth 5% more than you owe on your original mortgage loan. Assuming your home’s value has gone up since you’ve owned it, you will probably be in good shape here. This is also assuming you put some money toward a down payment and have stayed current with your monthly mortgage payments. Both of these will pretty much give you immediate home equity as long as the property value hasn’t come down since you purchased it.
For cash-out refinancing, the industry standard is usually a minimum of 20% equity in your home. Mortgage lenders aren’t likely to issue a refinance loan and let you borrow cash from your equity unless there is an ample amount to use as collateral.
Other Home Refinance Qualification Standards
Your home equity will only be one financial factor reviewed by your mortgage lender when you apply for a home refinance. They will look at your current income and employment situation. They will calculate your debt-to-income (DTI) ratio. And, they will run a credit check to determine your FICO score. All of these items will affect your qualified mortgage rate when refinancing.
Do I Present a Lending Risk?
Mortgage lenders are mainly looking to minimize risk. They want to issue loans to borrowers who have healthy finances and who are most likely to keep up with their mortgage payments. This protects the lender/bank, as well as the homeowner. A defaulted loan is bad for everyone involved and a foreclosure is a worst-case scenario. This is why lenders go through such a thorough qualification and approval process to minimize risk.
Having a higher home equity will definitely minimize your risk as a refi borrower. Your home equity is essentially viewed as collateral for your new loan. The lender knows the value is there in the property itself, so this provides security if you do happen to fall behind on your mortgage payments. A lower home equity means there is less of a safety net for both the borrower and the lender. You may still be able to qualify for a refinance loan with minimal equity, but you likely won’t get a great mortgage rate. Higher mortgage rates are generally required for borrowers who present more risk. The lower your risk profile, the lower your rate will typically be.
How Will a Refinance Affect My Home Equity?
This may depend on what type of refi you are getting. A standard home loan refinance will not affect your equity at all. You are simply refinancing your existing loan principal balance at a lower interest rate. You can lower your monthly mortgage payments and/or reduce the remaining loan term to a shorter payoff period. Otherwise, all the equity you have stays in your home and can keep building up as the property value appreciates and you continue to pay down your loan principal.
Your home equity will be affected if you are getting a cash-out refinance loan. In this situation, you are borrowing additional cash from your equity. Your new mortgage loan total will be higher (existing principal plus any equity taken out) and thus your equity will be lower. You can replenish your home equity over time as you pay down your new loan and if your property appreciates in value. However, the immediate impact will be a reduction in current home equity.
If you are ready to refinance your home loan in the Atlanta area, Moreira Team | MortgageRight can help you find the right lending solution and qualify for the lowest possible mortgage rate. Contact us today to get started with your refi!