Refinancing your mortgage doesn’t have to result in losing home equity. On the contrary, the primary goal of refinancing is to secure a new loan with lower interest rates, making repayments more manageable and enabling you to build equity more quickly.

However, if not approached carefully, refinancing can lead to long-term financial losses, and the process itself can impact your home’s overall equity. Before deciding to refinance, consider these factors to ensure you don’t diminish your hard-earned home equity.

How does refinancing affect the equity you have in your home?

Typically, refinancing does not alter your home’s market value. For instance, if your home is appraised at $300,000 and you owe $150,000 on your mortgage, refinancing doesn’t change the fact that your home is worth $300,000.

Refinancing itself doesn’t have to affect your home equity, but certain factors can impact it. Your home equity is determined by subtracting the balance owed on your mortgage from the home’s market value. However, during refinancing, your mortgage balance can increase in ways that may reduce your equity.

For example, refinancing involves closing costs, similar to those incurred with your original loan. If you choose to roll these upfront expenses into the new mortgage rather than paying them out of pocket, you’re effectively increasing your mortgage balance. This addition reduces your home equity.

A cash-out refinance can also impact your equity. With this type of refinance, you withdraw a portion of your home equity as cash, which increases your loan balance and subsequently decreases your equity.

Straight refinance vs. cash-out refinance

You can refinance your mortgage in two main ways: a straight refinance or a cash-out refinance.

Straight Refinance: Also known as a rate-and-term refinance, this option involves borrowing the exact amount you currently owe on your mortgage. The main benefit is that you can secure a lower interest rate compared to your previous loan, allowing you to pay down the principal balance more quickly. As you pay off the loan faster, you build up your home’s equity more rapidly. Therefore, a straight refinance can potentially help increase your home equity over time.

Cash-Out Refinance: This option is more complex and can significantly reduce your home equity. With a cash-out refinance, you borrow more than you owe on your current mortgage and take the additional amount as a lump sum. Essentially, you’re using a portion of your equity as collateral for this new loan, converting some of your ownership stake back into debt.

While you can use the cash for various purposes, it’s generally best for home improvement projects, repairs, or other investments that can add value to your home. This approach helps replenish your equity. Otherwise, taking cash out can substantially lower your equity, and it may take years of mortgage payments or a significant increase in property values to rebuild it.

What happens to your home’s equity when you refinance?

Refinancing can affect your home’s equity in both positive and negative ways. It’s crucial to account for lender fees, closing costs, and to have a clear understanding of your home’s current value. Here are the key ways refinancing can influence your home’s equity:

Lender appraisal

When you apply for a refinance, lenders will conduct an appraisal to determine your home’s current market value. This value can differ from your previous appraisal, impacting your new mortgage amount, your equity, and — if you’re opting for a cash-out refinance — the cash you can receive.

Appraisers evaluate your property based on its features, such as age, square footage, and number of rooms, as well as neighborhood factors like crime rates, school districts, and proximity to emergency services. They also compare your home with recently sold properties of similar size. Accurately estimating your home’s value is crucial; overestimating or underestimating it can result in losing money or missing out on better interest rates.

Fluctuating property values

Calculating your home equity starts with determining your property’s current market value, which can fluctuate based on real estate market conditions. As your home’s value rises or falls, so does the value of your home equity. Before taking out additional home loans, it’s important to consider market trends and forecasts to understand how they might impact your home’s value and, consequently, your equity stake.

Closing costs

If you choose not to pay closing costs upfront, many lenders offer the option to roll these costs into your refinance loan. For instance, if your closing costs amount to $5,000 and you’re refinancing $150,000, the lender can approve a total loan of $155,000. This means you’re borrowing against your home’s value to cover the closing costs, which effectively reduces your home equity by $5,000.

Why it’s important to consult with multiple lenders before refinancing

As with any loan, refinancing rates and costs can differ among lenders. It’s wise to consult with several lenders before committing to a refinance. This approach helps you understand typical refinancing costs and find the best offer.

“Before reaching out to lenders, use a mortgage refinance calculator to crunch the numbers,” advises Bell. “This tool can help you estimate potential savings or losses from refinancing. While a lower interest rate and monthly payment may seem attractive, if you plan to move in the next few years, the immediate savings might not offset the costs of refinancing.”

What to consider before refinancing your mortgage

Your home’s equity remains essentially the same when you refinance your mortgage with a new loan, but be mindful of fluctuations in home equity values, which reflect broader real estate market trends. Recent years have shown significant volatility in this regard.

For instance, during the pandemic, home prices surged, leading to record high home equity stakes in the third quarter of 2021. However, as interest rates began to rise in mid-2022, the housing market slowed, causing home equity growth to stall and even decline year-over-year in Q1 2023, the first drop since 2012.

By Q3 2023, the market started to rebound, with home equity values rising again. According to CoreLogic, U.S. homeowners with mortgages saw their equity increase by $1.5 trillion by the first quarter of 2024, marking a 9.6 percent year-over-year rise.

Several factors influence property values and, consequently, your home’s equity, including unemployment rates, interest rates, crime rates, and local rezoning. While real estate generally appreciates over time, it can do so unevenly and varies widely between regions.

Understanding the current state of your home’s equity is crucial before refinancing or taking out additional loans. Accurately assessing your equity helps avoid overpaying for a refinance, missing savings opportunities, or falling short of your financial needs.

How much equity do I need to have in my home to refinance?

To refinance a conventional mortgage, you typically need at least 20 percent equity in your home, meaning your current mortgage balance should be no more than 80 percent of your home’s appraised value, known as an 80 percent loan-to-value (LTV) ratio.

Government-backed loans, such as FHA, VA, and USDA loans, may have different requirements. For instance, FHA streamline refinances and VA loans might not require an appraisal, allowing refinancing even with minimal or negative equity.

“If you’re unsure about your equity or which refinancing option suits you best, consult with a mortgage professional,” says Bell. “They can provide personalized guidance and help you choose the most suitable option for your home and finances.”

Home equity loan vs. refinancing: What’s the difference?

Refinancing isn’t the only way to access your home equity. Here’s how a home equity loan differs from a cash-out refinance:

Both options involve using your home as collateral for new debt, but they operate differently. A cash-out refinance replaces your existing mortgage with a new one, potentially offering lower interest rates and a revised loan term if rates have dropped since your original loan. This can simplify your finances with a single monthly payment and might save you money on interest over time.

In contrast, a home equity loan, often referred to as a “second mortgage,” allows you to retain your original mortgage while taking out a new loan based on your home equity. This means you’ll manage two separate monthly payments. A home equity loan can be advantageous if you wish to keep your current mortgage interest rate unchanged.

Can I still take out a home equity loan after I have refinanced my home?

You can still obtain a home equity loan after refinancing, but you’ll need to have a certain amount of equity in your home to qualify. Lenders generally require you to maintain at least 15 to 20 percent equity.

If refinancing reduces your available equity below this threshold, you may need to wait until you’ve paid down more of your mortgage before you can take out a home equity loan. Typically, borrowers for home equity loans are at least one-third into their mortgage term and have built up a significant ownership stake.

In Conclusion

Refinancing itself doesn’t immediately affect your home equity, but various factors can impact your home’s value over time. Remember, your equity is theoretical until you sell your home and realize the value in cash. Until then, your equity position will fluctuate based on local real estate market conditions and your mortgage balances.

Before deciding on the amount to refinance, ensure you have an accurate appraisal of your home’s current value. Compare mortgage refinance rates and APRs, which include lender fees and closing costs. This will help you make a well-informed decision and maximize your home equity benefits.