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Refinancing a mortgage involves paying off the current loan and replacing it with a new financing arrangement. In many cases, refinancing only is an option if your home is worth more than your current mortgage balance. This difference between the amount borrowed and the amount the property is worth is known as equity, and the amount of equity you have is important because lenders are concerned about your loan-to-value ratio -- a comparison of the value of your home to the size of the requested loan. Although a minimum of about 20 percent equity -- an 80 percent loan-to-value ratio -- is the traditional standard, the actual requirement varies between different lenders and different loan programs.
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The LTV and Equity Calculation
To calculate LTV for an existing mortgage, divide your loan balance by the home's appraised value. For example, if your mortgage balance is $210,000 and the appraised value of your home is $300,000, the LTV is 70 percent. Subtract the LTV from 100 percent to determine the equity in your home. In this case, you’d have 30 percent equity.
Homeowners often consider refinancing an existing mortgage to take advantage of low interest rates and reduce monthly payments, to avoid a balloon payment on an adjustable rate mortgage nearing the end of its fixed rate period, or to cash out some of the home’s equity.
Lenders and loan programs offer a number of options for accomplishing these goals. Among the most common are traditional 15- and 30-year refinance loans, cash-out loans and government
programs such as the federal Home Affordable Refinance Program. Federal Housing Authority refinancing and Veterans Affairs refinance loans.
Lenders and loan programs generally use the LTV ratio rather than an equity percentage in qualifying a refinance request. The minimum requirement varies according to the loan:
- Traditional refinance loans and HARP loans require an equity/LTV of 20/80 percent
- A traditional fixed-rate cash-out refinance requires an equity/LTV of about 15/ 85 percent
- A traditional adjustable rate cash-out refinance requires an equity/LTV of about 25/75 percent
- Both the FHA and the VA have programs that can help upside down homeowners refinance a mortgage. These provide options for homeowners who have no equity or whose current mortgage is for more than the value of their home.
A high LTV home refinance usually will come with a higher interest rate. Additionally, fees and closing costs may increase the total loan amount even further. A refinance loan that exceeds 100 percent of your home’s value is unsecured and can’t be deducted from your taxes.
The Processing of Refinancing
The steps in refinancing a home loan depend on the lender or the program.
A traditional refinance works much like when you took out the original mortgage. During the three-step approval process, the lender will base a decision on your credit score, debt-to-income ratio and the value of your home, usually via a new appraisal.
In contrast, streamline refinance programs have less strict credit requirements, easier income and asset verification procedures and usually do not require a new appraisal.