Your equity represents the portion of your home that you actually own. You can calculate equity by deducting liens such as mortgages and equity lines from your home's market value. When you refinance your home, you may find your level of equity has increased or decreased even if the size of your home loan remains the same.
Economic factors such as unemployment levels and interest rates can have an impact on property prices because homebuyers are more scarce when rates are high and employment opportunities are few and far between. Crime rates, the redistricting of school zones and the location of the nearest fire station can also impact your home's value. Consequently, lenders order a new home appraisal whenever you submit a home loan application as your home may have gained or lost value since you took out your existing loan. Licensed appraisers compare your home with similarly size properties that have recently been sold. Some appraisers also base appraisals on the cost of rebuilding your home. Either way, the home appraisal represents the current market value of your house.
When interest rates are falling, you can attempt to refinance your existing mortgage with a new low rate loan. If the new loan balance is exactly the same as the balance on the old loan, you have taken out what lenders refer to as a straight refinance. Over time, you should start to build up equity at a faster rate than on your old loan because more of your payment goes to principal when you have a lower interest rate. Although a straight refinance does not cause your equity to rise or fall, you may become aware of price related changes in equity when your lender orders an appraisal on your home.
Some lenders allow you to roll your closing costs into a straight refinance loan. When this happens, you actually cash in some of your equity to cover these costs. Therefore, your level of equity in your home actually decreases as a result of the transaction. Rising or falling property prices may offset or exacerbate this loss of equity. However, even if you lose equity, you may still benefit financially over the long term due to the interest savings on the mortgage as a whole.
Cash Out Refinance
Home appraisals aside, your level of equity may drop dramatically if you decide to get a cash-out refinance mortgage. You can use one of these loans to extract equity from your home to pay off other debts, go on vacation or for any other legal purpose. Beyond just refinancing existing loans, you can also use a cash-out refinance to access equity even if you currently own your home free and clear. Government backed mortgage enterprises such as Freddie Mac and many lenders only allow you to tap up to 80 percent of your equity in the form of a cash-out loan. Therefore, you normally retain at least 20 percent of your equity even after a cash-out refinance.