Do I Lose Home Equity After Refinancing?

Refinancing doesn’t have to put a dent in your home’s equity, but there are factors that can. Lender fees, closing costs and changes in your home’s market value could positively or negatively affect your home’s equity over time. 

Homeowners usually refinance to swap in the interest rate on their primary mortgage for a lower one, so that they can build equity faster. In recent years, though, homeowners haven’t been able to take advantage of record-low interest rates. Data from Fannie Mae shows refinance application levels were down 75.6% year-over-year for the week of March 10, 2023. While today’s refinance rates are a far cry from the lows of 2020 and 2021, homeowners may feel some relief in 2023 as the Federal Reserve eases its pace of rate hikes.  

In today’s environment, it’s crucial to be up to date on your home’s current appraisal value as well as some of the key steps and costs involved with refinancing.

What is home equity and what factors influence it?

Home equity is the difference between how much you owe on your mortgage debt and how much your house is worth. If you have an outstanding balance of $75,000 on your mortgage, for example, and your house is worth $300,000, you have $225,000 of home equity. There are two key factors that affect home equity:

• The principal balance, which you chip away at with each monthly payment. Over time, you lower the total amount of debt you have to pay back and accumulate a greater piece of equity.
• The value of your home, which moves up or down after you buy it. In some cases, you might invest in the property by finishing your basement or remodeling your kitchen to increase its value. But the value may also change based on the broader housing market. Take a hard look at trends in your local market before taking out any additional home loans. If home prices are falling or rising dramatically, your home’s value may change accordingly.

It’s important to find out how much equity you have in your home before refinancing or taking out a different type loan -- like a home equity loan or HELOC.

How does a refinance affect your home equity?

When you refinance your mortgage, you replace your initial home loan with a new one. That doesn’t mean it has to impact your home equity, though. If you’re thinking about refinancing, it’s important to understand some of the key steps and costs involved.

Appraisal

When you refinance, a lender will require a professional appraiser to assess your home’s market value. This helps the lender verify that it will be able to sell the home if you default on the loan. The appraiser will look at comparable properties in your neighborhood to assign the value. If other home valuations have increased, your property value will likely go up, too. This can present opportunities: If you’ve been paying private mortgage insurance -- typically part of any conventional mortgage where the borrower doesn’t have 20% equity in the home -- an appraisal might allow you to stop paying those PMI premiums.

Closing costs

Refinancing isn’t free. The most recent data from ClosingCorp shows that the average 2021 refinance included $2,375 of closing costs (excluding taxes). Some lenders might offer you a no-closing-cost loan, which just rolls those costs into your total mortgage balance. In that case, you’ll be borrowing more money, which does translate to less equity.

Changing property values

Your property value can always change. As a homeowner, you clearly hope it gets bigger but that’s not always how it plays out, as the housing crash of 2008 reminded us. If your home value decreases, so does your equity, which can spell trouble. If you need to sell your home and it’s worth less than what you owe, you’re considered underwater on your mortgage.

Straight refinance vs. cash-out refinance

There are two options for refinancing -- a straight refinance and a cash-out refinance -- and they have different impacts on your home’s equity.

A straight refinance is often referred to as a rate-and-term refinance, which means that you’re replacing your existing mortgage with a new rate and a new term. A homeowner paying off a 30-year mortgage with a 7% interest rate might refinance into a 30-year mortgage with a 6.25% interest rate or a 15-year mortgage with a 5.75% interest rate. The goal with a straight refinance is to lower your monthly mortgage payment or accelerate your loan payoff. A straight refinance does not cause your equity level to rise or fall. 

A cash-out refinance, however, can have a much bigger impact on your equity. You are “cashing out” a portion of your equity. In this scenario, you replace your existing mortgage with another loan with a bigger balance -- hopefully at a lower interest rate -- so you have extra cash for other big expenses such as remodeling, paying for college or dealing with a large medical bill. Because you are cashing in on some of your home’s equity, your equity level is likely to decrease as a result.

Impact on your home equity: Cash-out refinance vs. home equity loan 

A cash-out refinance isn’t the only way to tap into the equity you’ve built in your home. Home equity loans and home equity lines of credit are two other options. Both will have an impact on your home equity, but there are two key things to consider before applying. 

Closing costs: Refinances may come with thousands of dollars of closing costs, but many home equity loans feature no closing costs as long as you keep the loan open for a minimum period of time, typically 36 months.

Lower borrowing amounts: With a cash-out refinance, you’ll be replacing your entire loan with a higher amount, which is ideal if you need a large sum of money. A home equity loan, however, can be for a much smaller amount of cash, which can help prevent you from the temptation of tapping too much of your equity. And a variable-rate HELOC offers the flexibility to only draw money when you actually need to use it.