Is Your Home Equity Ready? Key Signs It’s Time to Refinance

Key Takeaways

• You generally need 20% equity in your home to refinance, although it may vary depending on the refinance type.
• If your credit score has gone up or mortgage rates have gone down, that could signal a good time to refinance your home loan.
• Some refinancing options to consider include traditional refinancing, cash-out refinancing, and government-backed loans.

Understanding Home Equity

Home equity means the amount of ownership you have in your home. You can find it by subtracting the amount of the remaining mortgage from your home’s current value.

Suppose your home is worth $500,000, and you have $300,000 remaining on your mortgage. Your equity would be $200,000. If the home is entirely paid off, with no mortgage, then you’d have $500,000 in equity.

You can measure home equity in dollars, or you can express it as a percentage. In the example above, having $200,000 in equity on a $500,000 home would be the same as having 40% in equity, because 200,000 is 40% of 500,000.

How Much Equity Do You Need to Refinance?

The general guideline is that you should have 20% equity in your home before you refinance. Returning to our example above, 20% equity in a $500,000 home would be $100,000.

The actual amount of home equity you need varies depending on the type of refinance you’re going for. With a cash-out refinance, which replaces your existing loan with a bigger one and gives you the difference in cash, lenders may require 20% equity or more.

A rate-and-term refinance, which replaces your existing loan with one that has better interest rate and loan terms, might allow you to refinance with less equity.

The downside is that you might need to pay higher interest rates plus, private mortgage insurance (PMI) until you reach 20% equity on the refinance loan. PMI protects the lender from the risk that you’ll default on the loan.

Signs It’s Time to Refinance

Aside from growing equity, there are some other signals that let you know it may be a good time to refinance. Economic conditions may have changed, or your personal situation may be different than when you first applied for your mortgage. If you see one or more of the following indicators, it could be time to refinance your home.

Interest rates are favorable: If rates have dropped below what you’re currently paying, refinancing could save you money. For instance, if you took out a home loan when rates were at 6.5% but they’ve dropped to 5%, it could be wise to refinance and save. Keep an eye on interest rate changes so you know when they’re starting to drop.

Your home has increased in value: A significant increase in home value can tip the scales in your favor, too. Perhaps you’ve made a lot of home improvements, or property values in your neighborhood are rising. When your home grows more valuable, there will be an even bigger difference between what it’s worth and what you have left to pay off. If your $500,000 home is now worth $650,000, that’s like getting an instant $150,000 in additional equity.

Your credit score has gotten a boost: If you’ve been dutifully paying your bills on time every month and shrinking your debt, you may have noticed an increase in your credit score. High credit scores can make it easier to qualify for low mortgage rates. If your score has gone up, now could be a great time to take advantage by refinancing with a lower rate. At the very least, check out what you could qualify for with your new, higher score.

There have been changes to your financial situation: Whether your financial situation has improved or declined, it could mean a refinance is in order. If your income has gone up and you have extra funds available, consider refinancing to a shorter loan term. The monthly payment may be a little higher, but you’ll wind up saving thousands of dollars in interest in the long term.

On the other hand, you might also want to refinance if your income has been cut by job loss or other unexpected circumstances. Replacing your current mortgage with a new one that has a lower monthly payment can help you stretch your budget further until you get back on your feet again.

Evaluating Your Refinancing Options

There are several ways you could refinance your current loan.

Traditional refinance: Also called a rate-and-term refinance, this type of refinancing replaces your existing mortgage with a new one, changing the interest rate and/or the terms of the loan. You might choose a traditional refinance if you’re looking to change your monthly payment or lower your interest rate.

Cash-out refinance: With a cash-out refinance, you can tap the equity you’ve built for cash by replacing your mortgage with a larger one. You’ll receive the difference between your current loan and your refinanced loan in cash, which you can use for whatever you need.

Government-backed loan options: If you have a VA loan, you might consider an Interest Rate Reduction Refinance (IRRR), which offers a new VA loan with a lower interest rate. There are also cash-out VA refinance loans if you want a lump sum of cash up front.

You can refinance an FHA loan into a new FHA loan with a simple refinance or a Streamline Refinance, which doesn’t need as much documentation as other refinance loans. An FHA 203(k) refinance lets you roll the cost of home renovations into your new FHA loan, while a cash-out FHA refinance lets you tap your equity. You can even refinance from a conventional loan to an FHA loan if you like.

Other options: If you need financial flexibility but you don’t want to take on debt, there are alternatives to explore. Home equity agreements (HEAs) are one option that enable you to tap your equity without a loan, which means you won’t accumulate interest charges or need to make monthly payments. Unlock offers home equity agreements with flexible credit requirements or income restrictions, so you can access the equity you’ve built even if you have imperfect credit or unpredictable income.

Conclusion

You probably have enough equity in your home to refinance if you have 20% or more in home equity. You might be able to refinance with less equity than that, but it depends on the type of refinance and the lender’s policies.

It could be time to refinance if your finances have changed or mortgage rates have dropped. Make sure you consider all of your options to find the right fit for your situation. If home equity sharing sounds like it could suit your needs, Unlock makes it easy to see how much you cash you could access without a loan.