When do you have enough equity to refinance?

After you've stayed in a home for several years and faithfully made a mortgage payment each month, you may wonder if it is a good time to refinance your loan. If you proceed with this option, you'll want to start by checking how much equity you have built up in the property.

Refinancing has the potential to save you a good deal of money or make the loan more manageable. Ilona Bray, writing for the legal site Nolo, says you may be able to enjoy some long-term savings by bringing the interest rate to a lower level. You can also change the type of mortgage from an adjustable-rate loan to a fixed-rate one, or vice versa.

If you want to lower your monthly payments, you can refinance to extend the payment period. This gives you more time to pay off the outstanding amount on your loan, which will be diminished by the equity you've built up in the home. However, you'll end up paying more in interest over the length of the loan.

A lender will consider factors such as your debt-to-income ratio, credit score, and your home's value in negotiating a new loan. You may also have to pay some of the same costs you did to apply for the original home loan, such as title insurance and appraisal fees.

Having some equity in your home will increase your chances of getting approved for refinancing. Fraser Sherman, writing for SFGate, says you're more likely to be approved for refinancing if you have at least 20 percent equity in your home.

However, the equity requirements will also vary depending on the type of loan. Marcie Geffner, writing for the mortgage research site HSH, says you can refinance with as little as 5 percent equity if you have mortgage insurance. You might even be able to refinance with negative equity through the Home Affordable Refinance Program, although this program is set to expire at the end of 2016.

There are a couple of refinancing options available for loans offered through the Federal Housing Administration. Streamline finances are available for loans already insured by the FHA and allow a borrower to refinance even if they have negative equity. Geffner says that since all FHA loans require mortgage insurance, it may not make sense to refinance through the FHA if you have built up equity of 20 percent or more.

Streamline refinancing is also available through the Department of Veterans Affairs. If you use this option, you'll need to have an existing VA loan and refinance into a new VA loan.
In some cases, you may be able to get a cash-out refinance. Bray says this occurs when you take out a new loan for more than you owe on your current mortgage, giving you the difference in cash to use on home renovations or for other purposes. However, you likely won't be approved for a cash-out refinance unless you have a significant amount of equity in the home.

Your ability to get cash-out refinancing largely depends on the loan-to-value ratio, or how the outstanding balance compares to the home's value. Geffner says an 80 percent loan-to-value ratio—or 20 percent equity in the home—is usually needed for cash-out refinancing in conventional loans. She says a standard FHA refinance can cash out with an 85 percent loan-to-value ratio, but that cashing out is not an option for streamline refinancing.

You'll also need more equity if you include closing costs as part of your new loan. If you don't pay these costs up front, you'll need to take out a slightly larger loan or get a higher interest rate to pay for them.

Bray says if the closing costs are significant for the refinancing, you'll want to consider whether you will actually save money by taking this action. If you're lowering your interest rate, determine how long it will take these savings to offset the closing costs. If you don't think you'll stay in the home for that period of time, refinancing will cost more than it will save.

Before you get an appraisal, you can get an idea of how much equity you have in your home by determining how your home's value has changed. You can do so by checking property tax records, sales of comparable homes, and news reports on home sales and prices in your region.

If you have any questions, let me know.

-Chris B.