If you have equity in your home, you may consider refinancing. Do you need a certain amount of equity, though?
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Each lender and loan program is different. Some loan programs require a lot of equity, while others don’t require as much. Keep reading to find out how much you might need as well as how you can qualify for the refinance.
The Difference Between Equity and LTV
You may think that if you have equity in your home that you can refinance it. Unfortunately, not all equity that you have in your home is able to be touched. Most loan programs require a certain amount of equity left in the home. This helps protect the lender’s investment should you default on the loan.
This brings us to the term LTV, or loan-to-value ratio. This is the maximum amount of the loan that a lender will allow you to have compared to your home’s value. You’ll hear your lender talk about different LTVs, which means the maximum amount you can borrow.
Only one loan program allows a 100% loan-to-value ratio and it’s the VA loan. Veterans that have enough entitlement can borrow as much as the value of their home when refinancing. All other loan programs have lower LTV requirements, though.
You can figure out your maximum loan amount based on the maximum LTV that a lender allows. For example, if your lender says that you can borrow up to 80% of your home’s value, then you take 80% of your home’s current value.
Cash-Out or Rate and Term?
A big determining factor in the amount you borrow is the type of refinance you want. If you are just trying to lower your interest rate or better your term, you may be able to get a higher LTV than if you wanted to tap into your home’s equity.
Rate/term refinances mean that you want a more affordable or more favorable term. In this case, most lenders allow an LTV as high as 95% as you’ll only borrow around the same amount that you have outstanding now.
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If you want to tap into your home’s equity, though, you run a higher risk of default. Since you borrow more than you have outstanding now, lenders need to keep your LTV lower to make sure that you can pay the money back.
The Different Loan Programs
As we said above, each loan program has their own LTV requirements. If you just want a rate/term refinance, the following LTVs apply:
- Conventional loans – 95%
- FHA loans – 97.5%
- VA loans – 100%
If you want a cash-out refinance, you’ll have to deal with a lower LTV maximum for most loan programs:
- Conventional loans – 80%
- FHA loans – 85%
- VA loans – 100%
Does High Equity Help?
When you refinance, you have to qualify for it, just like you had to qualify for the home purchase. If you have more equity in the home than the program requires, it can help your case. Lenders look at this as a compensating factor. This can work in your favor if you have a lower credit score than the lender requires or you have a higher debt ratio.
Lenders look at the big picture when determining your eligibility for a loan, even a refinance. They want to know that you can afford the loan beyond a reasonable doubt. If you want to refinance, you should maximize your credit score and lower your debt ratio. If you can’t but you have equity in your home, it could help convince the lender to refinance your loan.
The bottom line is that the more equity you have in your home (and leave in it), the higher your chances of approval become. Of course, you have to qualify for the loan by having the right credit score and debt ratio. Your equity, however, is the driving factor because if you don’t have enough equity in your home, you will have to wait to refinance.