Do I Lose Home Equity After Refinancing?

How Does Refinancing Affect Your Home Equity?

Your home equity is the amount of your home value you actually own; you can find it by subtracting your mortgage balance from your home's current market value.

Example: If your home is worth $300,000 and you owe $200,000 on your mortgage, you have $100,000 (33%) equity in your home.

Depending on the type of refinance you choose, you may lose some of your home equity by taking out a larger loan. Other types of refinances don't decrease your home equity and may help you build equity faster.

Let's take a look at how each type of refinance can affect your home equity.

Rate-and-Term Refinance

With a rate-and-term refinance, you take out a new home loan to change your term, interest rate or both. If your new loan comes with a higher interest rate or longer loan term, a higher portion of your monthly payment goes toward interest. This slows down the process of building equity. Lowering the rate or shortening the loan term has the opposite effect: You'll speed up the equity-building process.

Additionally, your lender may order a home appraisal for the refinance. If the appraisal shows your home's market value increased since you took out the current loan, then your equity stake also increases. A lower home value, on the other hand, decreases the value of your equity stake.

Simplified Government-Backed Loan Refinance

A streamline refinance, available with government-backed home loans, simplifies the application and approval process. Depending on which type of simplified refinance you choose, you might be able to skip the credit check, the appraisal and some of the paperwork.

This type of refinance won't affect your home equity if you waive the appraisal. But changing the loan term or interest rate may impact how quickly you build equity.

No-Closing-Cost Refinance

Closing costs are fees you pay the lender to process your home loan. Some lenders offer a no-closing-cost refinance, which usually entails rolling your closing costs into your new loan instead of paying them upfront. If you choose to do this, your loan balance will increase by the amount of your closing costs. Your equity stake, in turn, will decrease.

Cash-Out Refinance

A cash-out refinance involves taking out a new mortgage for more than you owe, paying off the original loan and keeping the difference in cash. The amount you can borrow is usually limited to a certain percentage of the equity you've built, such as 80%. Because you're borrowing against your home equity to get the cash, the amount of your ownership stake decreases.

Cash-In Refinance

With a cash-in refinance, you take out a new mortgage and give the lender a lump sum of cash to shrink your principal. The new loan may come with a new interest rate and term. Because your new loan starts at a lower balance, your monthly payments should be lower going forward and your home equity increases.

Learn more: How to Calculate Home Equity

What Happens to Your Home Equity When You Refinance?

Several factors can influence your home equity when you refinance. They include:

• New appraisal: If an appraisal shows the market value of your home increased, then your equity increases. On the flip side, a lower market value decreases your equity stake.
• Closing costs: You'll lose some of your home equity if you decide to roll your closing costs into your home loan balance.
• Borrowing cash: When you do a cash-out refinance, you borrow money using your equity as collateral—thereby reducing your ownership stake in your home.
• Adding cash: If you decide to pay a lump sum toward your home loan principal, then your equity increases.
• Changing the loan term: Extending your loan term means you'll build equity more slowly, while shortening the term helps you build equity faster.

How Much Home Equity Do You Need to Refinance?

You'll typically need at least 20% equity in your home to refinance a conventional mortgage. Some lenders allow you to refinance with less equity, but they'll likely require you to pay private mortgage insurance (PMI)—increasing the amount you pay each month.

Other loan types may have different requirements. For instance, FHA loans, which are guaranteed by the Federal Housing Administration, put the equity threshold at 3.5% for rate-and-term refinances and 20% for cash-out refinances.

If you're looking to refinance, you can work with a lender to go over the process and check whether you qualify.

Learn more: When Should You Refinance Your Mortgage?

How to Rebuild Your Home Equity After Refinancing

Here are some tips for rebuilding your home equity after a cash-out refinance:

• Make extra principal payments. Consider making extra payments toward your loan principal if you can afford it. You'll pay off your loan balance faster while boosting your equity at the same time.
• Avoid using your home as collateral. You could drain your home equity by taking out home equity loans, home equity lines of credit (HELOCs) and cash-out refinances. If you need to borrow money down the road, consider getting a personal loan.
• Try boosting your home value. Some types of home renovations can increase your home's value—and, in turn, your equity. Making minor repairs, repainting and adding energy-efficient features are a few ways to boost your home value.
• Wait for your home's value to rise. Homes often naturally appreciate in value over time. In the past decade alone, the national average selling price rose by 80%, according to the Federal Reserve Bank of St. Louis. When home prices in your area rise, your property's value can increase as well as your equity stake.

The Bottom Line

Refinancing your home could be a good option if you need to change your loan term, borrow cash or meet some other financial need.

If you're planning to refinance, knowing where your credit stands is key to determining whether you'll get approved for a refinance loan with good terms. Check your credit report and FICO^® Score^☉ for free from Experian to see how your credit is faring and learn how to improve your credit if necessary.