Refinancing your home can be a bit tricky and the bank or broker who tries to sell it to you will undoubtedly be savvy in doing so. I constantly hear some of my best customers say they don’t want to refinance because they don’t want to add to their principal balance; but for some reason, they still want some equity and a lower monthly payment. It’s really funny from a broker’s perspective. The bottom line is, if you don’t plan on staying in the house for the full term of the loan (30 years typically) and you have some equity, refinancing can be beneficial.
There are 2 reasons people refinance:
1) lower monthly payment or
2) cash out.
Sometimes people want the best of both worlds, but you can’t get both. No matter your reason for refinancing, I suggest you have at least 25 % equity in your house before you move forward. For example if you have a $100,000 balance, your house should be worth at least $125,000 (or 25% more than the value). Why? Well, the first thing is that in this market you’re only going to be able to refinance at about 85% loan to value (LTV) of the market value. Meaning, you’ll only be able to refinance for $106,250. That leaves you with $6,250 to work with. Most, if not all, of that money will be eaten up in closing costs. If you actually want to pull out some cash, I’d say you need to have 35% equity in your home. Using our example from earlier would mean your house should be worth $135,000. At 85% LTV, your new loan would be $114,750; subtract your payoff ($100,000) and 5% closing costs ($5,000) and you’re left with $9,750 to play with.
Equity is the key component when deciding whether to refinance. I suggest waiting 2 to 5 years before considering a refinance, unless your home came with equity. If you play your cards right, the only disadvantage to your new refinance should be the fact that you’re adding to your principal balance. However, if you’re like most Americans, you’re not going to live in the house for 30 years so adding a little to your balance with equity left over shouldn’t put you in a bind. In fact, you can use it as a means to cash out twice: during the refinance and once you sell.