When homeowners consider refinancing their mortgage, they often weigh the potential benefits against potential drawbacks. One common concern is the impact on home equity - the value of ownership in their property.
In this article, we'll explore the concept of home equity, how it's calculated, and address the question: What happens to home equity when you refinance a mortgage?
What Is Home Equity?
Home equity represents the portion of your property that you truly own, calculated as the difference between your home's market value and the outstanding mortgage balance. As you make mortgage payments over time, and/or as the value of your home appreciates, your equity in the property typically increases.
Home equity also represents more than the mortgage loan being paid off. It can also be an asset that homeowners can borrow against in the future to meet important financial needs.
How Is Home Equity Calculated?
Your home equity is the difference between what the house is worth and what is still owed on a mortgage loan.
To calculate home equity, subtract the remaining mortgage balance from the current market value of your home. For example, if your home is valued at $300,000 and your remaining mortgage balance is $200,000, your home equity is $100,000. The calculation provides an indication of the financial stake you have in your property.
What Happens to Home Equity When You Refinance a Mortgage?
Refinancing a mortgage involves taking out a new loan to pay off the existing one, often with the goal of securing a lower interest rate, changing loan terms, or accessing equity for other financial needs. While the process of refinancing does not inherently reduce your home equity, it may impact it in several ways.
If you choose a cash-out refinance, where you borrow more than the remaining mortgage balance, your home equity will decrease. On the other hand, a rate-and-term refinance, where you replace the existing mortgage with a new one without taking additional cash, generally maintains your current level of equity.
It's important to consider the overall financial strategy behind refinancing and how it aligns with your goals. While a cash-out refinance may reduce immediate equity, it could provide funds for home improvements or debt consolidation, potentially increasing the home's value in the long run.
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