Refinancing to a lower home loan rate is a popular way to save some money, but you might need to have built up some equity in your home for it to make sense.
So, what’s equity? Equity is essentially the property’s present value, minus how much you still owe on the home loan. If you’ve been diligently paying off your home loan, it’s quite possible you have built up a sizable amount of equity in your home. This is true again if your home has managed to appreciate in value from when you first took out your loan.
If it’s been a few years, it’s probably only natural to look at refinancing to a better home loan rate, especially in this low-interest environment. After all, a competitive home loan only a few years ago might be noncompetitive now. However, how much equity do you need to have to for refinancing to make sense?
For all intents and purposes, it can be handy to consider the equity in your home as a deposit for your refinanced home loan.
An ideal figure to aim for is 20% equity in your home, but more details on that later. This means that if your home is worth $1 million, you’d ideally want your outstanding loan size to be no more than $800,000. This is virtually the same as the loan-to-value ratio (LVR), which would be 80% in this scenario.
Many of the most competitive home loans require maximum LVRs of 80% i.e. a 20% deposit or 20% equity built up.
The main drawback in refinancing without having at least 20% equity is that it’s likely you’ll have to pay lenders mortgage insurance (LMI). Depending on the loan size, this could work out to be many thousands or tens of thousands of dollars.
For example, if you’ve built up $90,000 in equity on a home worth $600,000 (i.e. 85% LVR, or 15% equity), your LMI premium could cost more than $6,000, if you’re an owner occupier on a 30-year mortgage.
Another factor to consider, too, is that if you’ve paid LMI on your initial home loan, it’s likely unable to be transferred to your new home loan. It is possible you can get a rebate on the LMI, but usually only if you’ve held your home loan for no longer than two years or so. In any case, you’ll have to ask your lender.
The cost in LMI premiums could be expensive enough to outweigh any savings you’d have by refinancing in the first place. Of course, this depends on how much your old home loan interest rate was, compared to the refinanced interest rate, versus any capital gains you’ve made on the property. Some quick napkin maths could be enough to find out if refinancing without 20% equity is worth it.
When refinancing to a new home loan, your home’s equity essentially acts as your deposit. A million-dollar home value with an $800,000 mortgage essentially means you have 20% equity.
Like with a home deposit, if you have less than 20% equity it’s likely you’ll have to pay lenders mortgage insurance. This could add up to thousands of dollars, depending on your equity and the home’s value, and could be enough to outweigh the gains in refinancing in the first place.
If you’re ready to get a better deal on your home loan, speak with one of our lending specialists today to talk about refinancing.