Building equity in your property makes it easier to refinance, but if you don't have enough equity you could be worse off.
When you choose to refinance your existing home loan, you should take into account the amount of equity you’ve built up in your home as this can determine your refinancing options. If you don't have enough equity refinancing is a bad idea. In short:
- More equity means a lower loan-to-value ratio (LVR), which means some lenders will offer you a lower rate.
- If you refinance with an LVR above 80% you'll have to pay lender's mortgage insurance, even if you already paid it.
So although you may have found a good refinancing deal, refinancing may not be the best option if you have to pay LMI twice.
Read on to find out how much equity you need to refinance.
First up: What is equity?
When you make payments towards the principal amount of your home loan you build up equity in your home. The equity is the difference between your home's value and what you have left to repay on your loan.
This is the money you can expect to remain if you sell your home and repay your loan with the proceeds from the sale.
For example, if you live in a home worth $750,000 and you still have to repay $250,000, you have $500,000 in equity. The equation for equity is given below:
Equity = property value - outstanding loan amount
How much equity do I need when refinancing?
Building equity in your home is particularly important if you plan to go down the refinancing path. Many loans come with a maximum LVR of 95%, which means you cannot borrow more than 95% of the value of your home. What this also means is that if you wish to refinance you must have at least 5% equity in your home.
In order to qualify for a refinance mortgage, you should have at least 20% equity in your home.
Applying for a refinanced home loan with no equity is difficult unless you can get someone to go guarantor. Find out more about how you can refinance your home loan with little or no equity.
Remember that lenders look at your equity as a means to assess risk. The more equity you have, the lower risk you present to the lender.
Refinancing home loans comparison
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What if I don't have at least 20% in equity?
When you choose to refinance without at least 20% equity in your home, there's a good chance you'll have to pay LMI again. This is because you cannot transfer the existing LMI to the new loan, despite the fact that your previous lender is no longer at risk.
While getting a rebate when you terminate your LMI policy is possible, it’s crucial that you ask for it. Most LMI policies don't offer rebates if you've held your home loan for longer than 12 or 24 months. Even if you do get a rebate, this is usually not for the full amount. If you have to get LMI again, you could pay thousands.
Consider LMI costs in the following examples which use the Genworth LMI calculator.
|Home value||Equity||LVR||LMI cost|
As you can see, the cost of LMI can be highly expensive which can outweigh the value of any savings you could net from switching lenders.
Before comparing refinancing options, find out how much equity you have in your home. If you don’t have a 20% deposit saved but aren’t far off the mark, it might make sense to wait until you've built up a higher amount of equity. Check out this helpful guide to paying off your mortgage faster (and thus building equity).
Alternatively, you can consider applying for a guarantor home loan or applying with specialist banks that may have less stringent lending criteria for refinance mortgages.