What is Home Equity? The Value That Matters When You Refinance

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Home equity represents what your home is worth, based on a difference between your home’s value and the amount you still owe to your mortgage lender.

Refinancing your home is a smart option because it allows you to get a better interest term and rate. But how much equity do you need to refinance a mortgage loan, and what is it?

What does this number mean

Home equity simply refers to the difference between the value of your home and the remaining balance on your mortgage or mortgages. Naturally, since home values fluctuate, your home equity changes according to the appraised value of your home. In addition, as you make mortgage payments and pay off your loan, you are increasing your home equity.

For example, if your home value is currently $200,000 and you have paid off $20,000, you have 10% in home equity. To calculate your home equity, use this equation: (amount you have paid off ÷ current home value) X 100 = equity. So, using the numbers from the example above: (20,000 ÷ 200,000) X 100 = 10% equity.

Why is home equity important?

So you’ve figured out “what is home equity,” but now the question is “what is home equity doing for me?” Home equity is considered an asset, a quantifiable amount that you own. You can use that money for investments in the future like buying property, retirements, or other significant purchases.

If you sell your home, your equity could be used to pay your closing costs. Any leftover equity would be yours to keep for savings, investments, or a down payment on another home.

Private Mortgage Insurance (PMI) is typically required for all conventional loans with less than 20% in home equity. The amount you pay in PMI varies according to how much home equity you have. So the higher your equity, the lower your PMI premiums will be.

The interest rate you pay also depends, in part, on your loan-to-value ratio. If you have just 5% or 10% in equity, your interest rate will be slightly higher than someone with 20% equity.

How much home equity do you need to refinance?

Your options for refinancing depend on your credit profile as well as your home value, which is based on your local market. If you’re thinking about refinancing, you should use a refinance calculator to determine if it’s the right time for you.

Most conventional lenders require at least 10% home equity for a refinance. If you have less than 20% in home equity, you will have to pay PMI, which will add to your monthly payments. However, if you are already paying PMI, or if your interest rate is higher than today’s mortgage rates, a refinance may still make sense.

If you are interested in refinancing, you will need to have an estimate of your home value before you apply, and in most instances (although not always required) an appraisal as well. A realtor can give you an idea of how much your home is worth based on recent sales of comparable homes.

Refinancing with low home equity

Even if your home equity is under 20%, there are options. It’s a good idea to look into federal government lending agencies who will offer you financing even if you have low equity.

You can refinance with a Federal Housing Administration (FHA) loan with just 3.5% in home equity, but be aware that you will need to pay mortgage insurance with all FHA loans. Most FHA insurance must be paid for the entire loan term.

Veterans Affairs loans and US Department of Agriculture loans are also popular financing options backed by the government.

The best way to find out if you qualify for a refinance is to have a free consultation with a reputable lender like a bank or a mortgage company.

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