Refinancing is something that most people will do at some point in their home ownership years. The reasons are many; sometimes it’s to get a better rate, sometimes to combine a first and second mortgage. Still others will refinance to take money out from the equity on the home and pay bills or do renovations. Whatever the reason, equity plays a major role.
What Is Equity?
Simply put, equity is the difference between the value of your home and what you owe on it. Although the term is very common, the truth is that not every homeowner has equity, and in fact some may be in the opposite position.
Equity increases over time when, as a general rule, the value of a home increases while at the same time the mortgage loans are being paid down. In difficult economic times, equity may build slowly or even be lost.
What Does Equity Have To Do With Refinancing?
While it is possible to refinance a home in which there is little to no equity, it is more difficult. You can refinance for a better rate, but you won’t be able to take any money out on the loan.
When the house is “upside down,” meaning that the amount owed is higher than the current value of the home, refinancing becomes much more difficult. In most cases this situation will not qualify for a refinance, although many mortgage companies do allow refinances up to a certain percentage above the market value.
Refinances in these situations can be done, but they are a little different from doing a refinance with equity.
Many people refinance in order to take some cash out of the home’s equity. When you do this you are drawing on the value of your home. Taking out cash against the equity you have in your home can be a helpful way to pay off bills or take on renovations. It’s important to note, however, that it comes with some risk.
If you refinance and use up all the equity in your home, and then the value of your home drops, you could find yourself upside down. You will also be unable to use that equity in the future should you decide to sell and need a down payment on your new home. Keep these things in mind before you make the decision to proceed with a cash-out refinance.
The equity you have in your home makes a big difference in the type of refinancing available to you, making the two closely related.