Homeowners with plenty of equity have likely refinanced more than once during the years of low mortgage rates, but other homeowners were prevented from refinancing because their home value dropped after the housing bubble burst. Most lenders require equity of at least 5 to 10 percent to approve a conventional loan refinance and FHA loans require 2.75 percent in home equity, yet many homeowners who would have benefited from refinancing were under water on their home loans.
Rising home equity equals refinancing opportunity
Home prices rose by 12.2 percent between May 2012 and May 2013, according to the Case-Shiller 20-city composite home price index. If your home value has risen, you may have an opportunity to refinance now. Compare mortgage rates to determine whether your current interest rate is higher than today's rates.
Three reasons to refinance
1.You can lower your interest rate. If you've been stuck with a mortgage rate of 6.5 percent or higher because you lacked the home equity to refinance, you can switch now to a mortgage with a lower rate. While you may have missed the window of mortgage rates under 4.0 percent, refinancing from 6.5 percent to 5.0 percent on a $300,000 loan will save you $286 per month. Remember, too, you're refinancing a lower balance than your original loan. If you've been paying on that $300,000 loan for seven years, for example, your balance is $265,970 and your payment will actually drop by $469 on a new 30-year loan at 5.0 percent.
2.You can eliminate mortgage insurance. If you've been paying private mortgage insurance (PMI), it should be automatically eliminated once your loan-to-value reaches 78 percent. PMI is required in loans with a loan-to-value of more than 80 percent. If your home value has risen enough that you have 20 percent in home equity, then you can lower your monthly mortgage payments with a combination of a refinance and eliminating PMI.
3.You can switch from an FHA loan to a conventional loan. FHA loans typically have higher mortgage insurance requirements than conventional loans; so if you have an FHA loan, you should compare mortgage rates and mortgage insurance premiums to see if you can lower your payment. One option for a conventional loan that isn't available on FHA loans is "lender-paid" mortgage insurance. Many conventional lenders will approve a 95 percent loan-to-value refinance and charge a slightly higher mortgage rate to cover the cost of the PMI. You need excellent credit to qualify for a refinance with lender-paid mortgage insurance and at least 5 percent in home equity.
The best way to find out if a mortgage refinance could benefit you financially is to consult with a lender who can review your current loan and your credit to determine your refinance options.