Refinancing your mortgage does not have to impact your home equity. If your home appraises for $250,000 and you owe $150,000 on your mortgage, refinancing that mortgage does not change the fact that your home is worth $250,000. The goal of the refinancing process is to take out a new loan to replace your mortgage in order to reduce rates and 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 impact your home’s equity overall. Consider lender fees, closing costs and your home’s up-to-date value before deciding to refinance.

What to consider before refinancing your mortgage

Your home’s equity remains intact when you refinance your mortgage with a new loan, but you should be wary of fluctuating home equity value. Several factors impact your home’s equity, including unemployment levels, interest rates, crime rates and school rezoning in your area.

Home equity hit a record high in the third quarter of 2021 due to rising home prices, making it a great time for homeowners to take advantage of their home’s value. It is, however, important to find out for sure how much equity your home has 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 your home’s value.

What happens to your home’s equity when you refinance?

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.

Lender appraisal

Lenders conduct an appraisal when you submit a loan application, which is why you should know the current market value of your home. Your home could have increased and decreased in value since your last appraisal.

Appraisers will consider 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 been 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.

Closing costs

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 loan you $155,000, borrowing against your home’s value and reducing your equity by $5,000.

Fluctuating property value

The real estate market can be variable and your home’s equity can increase and decrease based on these changes. You should always consider market forecasts and trends and how your home’s value will be affected before taking out any additional home loans.

Straight refinance vs. cash-out refinance

There are two ways that you can refinance your mortgage: a straight refinance or a cash-out refinance.

A straight refinance is when you borrow exactly the same balance that you owe on your mortgage. This 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.

A cash-out refinance mortgage is a lot riskier and could dramatically hurt your home’s equity. These loans tap into your home’s equity as collateral, and you can use these loans for a variety of purposes. It is generally not a good idea to cash out refinance unless you are certain you will be able to make timely payments in full. It is also generally best to use these types of loans for home improvement projects or anything else that will put value back into your home. Otherwise, you risk hurting your home equity.

Bottom line

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 you do not fully gain your home’s equity until it is sold, so your equity position over time will vary depending on home prices in your market and loan balances on mortgages.

Make sure you are up to date on your home’s current appraisal value, and compare mortgage refinance rates before deciding if and for how much you would like to refinance.