In this blog, we will be covering and explaining what home equity is and how home equity affects the amount you can take out on a cash-out refinance. We will explain why home equity is important for homeowners wanting to do a cash-out refinance. Equity is the net value homeowners have in their homes. It is calculated by taking the market value of the home and subtracting the amount homeowners owe on the home. The difference is called Home Equity.
Skyrocketing Home Values Make Cash-Out Refinance Attractively
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. Today, millions of Americans who purchased homes a few years ago have reaped the rewards on an average of 40%. The economy is literally upside down with inflation soaring.
Homeowners with plenty of home equity should think of doing a cash-out refinance and paying off the high-interest credit cards and other debts. In the following paragraphs, we will cover and discuss how to utilize your home equity and think about doing a cash-out refinance like millions of Americans are doing.
What Does Home Equity Mean For Homeowners?
For example, if the home buyer purchases a home for $100,000 and puts in a 3.5% down payment, the home equity they have is $3,500. However, if homeowners 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 the real estate agent’s commissions and closing costs by the home seller.
How Is Home Equity Built During The Loan Term
Each time homeowners make 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 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 fewer 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 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 retirement saw their home equity disappear before their eyes. Many thought that they could never ever sell their homes and were stuck there.
How The Recession Affected the Home Equity of Homeowners
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 national real estate market is so hot right now that most home sellers are not even offering seller concessions to home buyers. For every home listed, there were three to four offers. Sellers getting $50,000 over list price was not uncommon. 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 variables to take into account when calculating home equity. The market value of the home is determined by the appraisal of the home and the mortgage loan balance. For example, if the home buyer purchased a home back in 2009 for $200,000 and put in a $10,000 down payment where the mortgage loan balance was at $190,000, they had 5% equity in the home at the time of purchase.
The figure now the mortgage loan balance dropped to $181,000 from the principal portion payments of mortgage payments. Say the home drops in value to $198,000 via a home appraisal. Homeowners have an 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.
How Does Inflation Affect Equity?
It is no secret the economy is in chaos and unstable. Mortgage rates have skyrockted to over 6.50% from a low of 2.5% just a little over a year ago. The housing market has gone up over 40% in the past two years. The economy is very unstable where we are getting many conflicting reports on why our economic state is the way it is. One of the most frequently asked questions by our viewers and clients is how does inflation affect home equity? Mike Gracz, an associate contributing editor at Gustan Cho Associates issued by following statement:
When Can I Pull Equity Out Of My Home?
Most people who owned their homes for the past few hours have seen handsome gains in their home equity. Michelle McCue, a regional managing director at Gustan Cho Associates said the following:
Let’s take this case scenario example further. Let’s fast forward another year too late 2018 and now the home has a market value of $202,000 and the mortgage loan balance has dropped to $177,000. Home equity now has increased to 12% or $25,000 due to the combination of the mortgage loan balance decreasing and the market value of the home increasing.
What homeowners owe on their home loan is much more important than what they have paid for their home. Changes in home equity will not alter the mortgage loan amount. In the event, that home value skyrockets 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 80% 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.
October 7, 2022 - 5 min read