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Refinancing your mortgage does not have to negatively impact your home equity. After all, the goal of the refinancing process is to get a new loan that’ll reduce your 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 impact your home’s equity overall. Here’s what to consider before deciding to refinance, to ensure you don’t lose your hard-earned home equity stake.
How does a refinance affect the equity you have in your home?
Usually, it doesn’t. If your home appraises for $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 a refinance, your mortgage balance can be impacted and increased in various ways, which decreases your equity.
For example, when refinancing your mortgage, there will be closing costs to be paid as part of the process. If you opt to have the closing costs rolled into the new mortgage, you’re increasing the mortgage balance — the amount you owe — and thus decreasing your equity — the amount you own.
Similarly, a cash-out refinance can impact your home equity. This type of refi means you are pulling money from your equity to receive as ready money. To provide you with that cash, the lender increases your mortgage balance to cover the lump sum payment. And once again, your home equity is diminished.
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 (aka a rate-and-term 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 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 a borrowed amount.
While you can use the cash 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.
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 values, which reflect residential real estate prices in general.
For example, home equity hit a record high in the third quarter of 2021 due to rising home prices. Then, with the housing market slowing for much of 2023, home equity actually declined. Data from CoreLogic from the first quarter of 2023 shows that homeowners who hold mortgages experienced a total home equity decrease of $108.4 billion since the first quarter of 2022. That amounts to a loss of 0.7 percent year over year. The average homeowner in the United States has lost about $5,400 in home equity since the first quarter of 2022.
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 find out for sure 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 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.
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.
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.
Can I still take out a home equity loan after I have refinanced my home?
It is still possible to take a home equity loan after refinancing, but in order to qualify for the loan, 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 home and typically the requirement is 15 to 20 percent equity.
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.
Bottom line on home equity and refinancing
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.