Home Equity And How It Affects Cash-Out Refinance Mortgages


Home Equity And How It Affects Cash-Out Refinance Mortgages

This BLOG On Home Equity And How It Affects Cash-Out Refinance Mortgages Was UPDATED On August 27th, 2018

Home Equity Explained:

Home Equity is the amount of value homeowners have in their homes:

  • It is calculated by taking the market value of home and subtracting the amount homeowners owe on the home
  • The difference is called the Home Equity
  • Home Buyers who purchase their home will only own a portion of the home until the mortgage loan balance is paid off where then they will fully own the home
  • For example, if home buyer purchases a home for $100,000 and put 3.5% down payment, the home equity they have is $3,500
  • However, if homeowner decide to sell their home right after they have bought the home, the equity may disappear
  • Or worse yet, they may need to come up with more money to close on their home sale
  • This is because they need to take into account the fees and costs such as real estate agent’s commissions and closing costs by the home seller
  • Each time homeowners makes their mortgage payment, a portion of that payment will go towards paying down the principal of the mortgage loan balance
  • The rest will go towards paying for the mortgage interest payments
  • The principal portion of mortgage payments increases home equity
  • This is because it is paying down the mortgage loan balance
  • As homeowners continue to pay down their mortgage loan balance amount and more funds will go towards building the equity and less funds will go towards mortgage interest payments

Home Equity Changes Over Time

The value of homes fluctuates with the real estate market.

  • For example, millions of homeowners have lost most or all of their equity in their homes during the 2008 Real Estate And Mortgage Meltdown
  • Many homeowners were left with negative equity where their mortgages were higher than the value of their homes
  • This is often called having a mortgage underwater
  • Tens of millions of homeowners who had tens of thousands of dollars in home equity and were counting on the equity in their homes for retirements saw their home equity disappear before their eyes
  • Many thought that they could never ever sell their homes and were stuck there
  • Some areas like many parts of Florida and California had property values drop almost 50%
  • Foreclosure and Bankruptcy rates hit a historical high in the United States
  • The lucky home buyers who purchased their homes starting in 2009 and 2010 when home prices hit rock bottom saw their home equity rise double digits year after year
  • The South Florida real estate market is so hot right now that most home sellers are not even offering sellers concessions to home buyers
  • Homes that are under $200,000 in South Florida are selling the minute it goes up on the market
  • A large percentage of home buyers are cash home buyers and many are purchasing properties sight unseen

Calculating Home Equity

There are two variable to take into account when calculating home equity.

  • The market value of the home which is determined by the appraisal of the home and the mortgage loan balance
  • For example, if home buyer purchased a home back in 2009 for $200,000 and put a $10,000 down payment where the mortgage loan balance was at $190,000, they had 5% equity in home at time of purchased
  • Figure now the mortgage loan balance dropped to $181,000 from the principal portion payments of mortgage payments
  • Say home drops in value to $198,000 via a home appraisal
  • Homeowner have a 8.5% equity in their home or $17,000 which is derived by subtracting $181,000 ( Loan Balance ) from the market value of the home today of $198,000
  • Lets take this case scenario example further
  • Lets fast forward another year to late 2018 and now the home has a market value of $202,000 and mortgage loan balance has dropped to $177,000
  • Home equity now has increased to 12% or $25,000 due to the combination of mortgage loan balance decreasing and the market value of home increasing
  • What homeowners owe on their home loan is much more important than what they have paid for home
  • Changes of home equity will not alter mortgage loan amount
  • In the event if home value sky rockets upwards, owners have increased the equity in their home but the amount they owe still remains the same

Importance Of Home Equity For Cash Out Refinance Loans

Home Equity is like cash in the bank. Homeowners who need cash to consolidate their debts, pay off certain debts, or need cash for other reasons can consider doing a cash-out refinance mortgage . A cash-out refinance mortgage can only be done if the homeowner has equity in their home. The refinance mortgage lender will pay off the existing mortgage and will give additional funds up to the maximum loan to value they qualify for. The maximum amount of cash-out they can get on FHA Loans is up to 85% loan to value. The maximum cash-out refinance mortgage a homeowner can get on a conventional loan is up to 80% loan to value. VA allows up to 100% cash out refinance on VA Home Loans.

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