How much equity I need to refinance at best mortgage rate? : Bad Credit Advisor

How much equity I need to refinance at best mortgage rate?

Q: How much equity do you need to refinance to get best mortgage rate? I was hoping you could give me some clues as to what look out for. Thanks.

A: How much equity you need to refinance, depends on what exactly you are trying to do. To obtain the best interest rate you must have 20% equity at the very least - that is, if you simpy want to lower your mortgage rate. This is called rate and term refinance. If you want to take some cash out of your home equity, called cash-out refinance, you better have at least 25% of equity left with new mortgage. So newly appraised value of your house is the crucial element. How much equity your house have? Here is an example - if your house is worth $150,000, with $120,000 mortgage, your equity is $30,000 in dollar terms or 20% in ratio terms - calculated by subtracting mortgage amount from value and dividing by value -
$(150,000 - 120,000)/$150,000 x 100% = 20%
Note that lenders think in reverse terms of Loan To Value (LTV), or mortgage to value ratio, in this case it is
$120,000/$150,000 x 100 = 80%.
Now, with that explained, understand that we are not even discussing your credit scores and income/assets situation - critical things to qualify for refinance, but simply assuming 720 middle score and 38% debt to income ratio, and you need to read further -

If you have more than one loan, and most homeowners have no more than two with the second often in the form of home equity line of credit, the question How Much Equity Do I Need to Refinance must take this second loan into account. If your house is worth $150,000, with $120,000 first mortgage and $15,000 second, your Combined Loan To Value (CLTV) is calculated by dividing the sum of both mortgages by home value - $(120,000 + 15,000)/$150,000 x 100% = 90%, and your equity is only 10% - not much. If you have more than two loans against your property, they all must be added.

First important thing to understand is that if your LTV (not CLTV), goes above 80%, you will be penalized by paying Private Mortgage Insurance (PMI) in a form of monthly dollar premium, which pretty much is not tax deductible, or by having Lender Paid Mortgage Insurance (LPMI) in a form of higher mortgage interest rate, which is tax deductible. Read carefully, see PMI and LPMI calculations, take into account your present home value to see if refinancing even makes sense. As the PMI and LPMI formulas may change, always consult with your broker or banker on current numbers. Also, it came to my attention that many loan officers, particularly in the banks, have very little knowledge on PMI calculations, often scaring borrowers away. Always double check.

Second important factor is closing cost. If your LTV is dangerously close to 80% threshold, rolling closing cost into new mortgage is often out of question, as it can upset your delicate LTV. You pay it out of pocket or get lender to pay for it. As an example consider $4,000 closing cost on $120,000 mortgage with home valued at $153,000. Your equity of $33,000 is enough for LTV of 78.4% = $120,000/$153,000. By rolling closing cost in to the mortgage you now get LTV of 81% = $124,000/$153,000, changing the whole refinancing game. Your LTV could be just over 80%, something like 80.5%, but unless appraiser gives you a higher value, someone has to pay closing cost.
Note - it is aways better to go with mortgage broker instead of bank loan officer, if you want to have your closing covered. And there is no such a thing as too much equity as you never know how lending terms change tomorrow.

Now the cash-out refinance situation, where how much equity you will have left with a new higher mortgage is quite important for your mortgage rate. 25% equity or 75% LTV is the standard right now. Many banks will not do cash-out refinance if your LTV is higher than 75% with today's Freddie Mac and Fannie Mae guidelines. And more, likely stricter changes are coming in just a couple days. But what this all means in dollar terms, for example, is that you can't take more than $12,500 out from your existing home equity, with present $100,000 mortgage and $150,000 value, because by going over amount of 112,500, you are exceeding 75% LTV threshold. Here are your calculations -

New LTV is not exceed 75% to get the best interest rate or even get to refinance, so new mortgage is not to exceed $112,500 = $150,000 x .75, which leaves you with $12,500 = $112,500 - $100,000. And then do not forget that either you or lender has to pay the closing cost. Or you can roll it into new mortgage, so the cash-out amount gets lower.

Again, in conclusion, how much equity you need to refinance to obtain the best rates is only important as long as you meet income, assets and credit score guidelines.

Wed Dec 31, 2008 03:12PM by Tony | More in Mortgage | Comments (0)

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