One of the key metrics lenders use to determine whether you qualify for a loan is the amount of home equity you have. Equity is the difference between the appraised value in your home and the amount you owe on it. You can see gains in home equity in two ways: the first by chipping away at the principal of your loan, and the second by an increase in the market value of your home over time. It is an advantage to have greater equity in your home if you are interested in refinancing, and there are several metrics that help you understand the answer to the ever-popular question: How much equity can I borrow from my home?
The amount owed on a loan divided by the estimated value of the property.
Before a lender loans money or approves a refinance, several numbers are crunched to assess and evaluate the risk involved. One of the numbers is the loan-to-value ratio (LTV). To calculate the LTV ratio, divide the amount of your mortgage by the appraised value of your property.
Example: You put $20,000 down on a house that appraises for $100,000, and your mortgage is $80,000.
$80,000 ¸ $100,000 = 0.80 = 80% LTV
Your LTV ratio is like a golf score — the lower, the better. The basic idea behind the LTV ratio is to evaluate risk, and the general theory goes that if LTV ratio is low, a borrower is considered less risky; if LTV ratio is higher, the higher the risk to lend.
The Costs Of A High LTV Ratio
What are the potential pitfalls of sporting a higher LTV ratio? As a rule of thumb, an LTV ratio of 80% or below is acceptable for home loan refinance. An LTV ratio that is higher is usually accompanied with additional expenses, like higher interest rates or the requirement of private mortgage insurance (PMI) that provides a layer of protection for the lender. PMI makes it easier for a lender to give a borrower a loan because it covers some of the risk involved, and it is often required when a homeowner puts less than 20% down on a conventional loan.
Another common consequence of a high LTV ratio is the difficulty of getting approved altogether. Each lender is different just like each borrower is different, and different lenders decide differently about how much risk they are willing to take. Get in touch with Mr. Cooper to find out more about LTV ratio (and get help calculating yours).
It should be noted that the LTV ratio is not the end-all-be-all factor of home loans and refinancing, and while it is important, there are other factors that lenders consider — your credit score, income, debt, savings, and the appraised value of your home.
An option for many homeowners who have built up a substantial amount of home equity is cash-out refinancing. Through this process, homeowners secure a new home loan for a greater amount than what is actually owed on the home so that they can receive cash that’s often spent on home renovations, college tuition, and paying down non-mortgage debts.
Keep in mind that when you refinance into a new home loan and take cash out, the terms and interest rates could change. Make sure you know what the changes will be before you finalize a cash-out refinance, and always weigh your options with an experienced mortgage professional.
A cash‐out refinance increases your mortgage debt and reduces the equity you may have in your home. Your monthly mortgage payments may be higher.