Your Key to Refinancing: Loan-to-Value Ratio
When deciding if you qualify for a mortgage refinance, the loan-to-value ratio (LTV) is an important metric used by lenders to determine your eligibility. Your LTV will not only help determine whether or not you qualify, it can also help a lender select your terms, APR and other aspects of your loan.
For the typical refinance, loan-to-value ratio also determines if you’ll need something like mortgage insurance, or if the lender will require extra protections. But, what is an LTV?
Simply put, your LTV is the ratio of how much you owe on your current mortgage loan divided by the current value of your home. So, if your home is valued at $100,000 and your current mortgage is $80,000, your LTV is $80,000 divided by $100,000, which equals 80%.
If you find it easier to calculate your equity, you can also use this to estimate your LTV. Simply subtract the equity in your home from its total value, then divide that new number by your home’s total value. This works because your home’s current value is roughly equal to your mortgage plus your equity.
Equity Needed to Refinance a Conventional Loan
You’ve probably heard that you need at least 20 percent equity—or an LTV of 80 percent or less—to get a conventional loan to refinance your mortgage. However, that’s not exactly the case.
Strictly speaking, you only need 5 percent equity in most cases to get a conventional refinance. However, if your equity is less than 20 percent, then you’ll likely face higher interest rates and fees, plus you’ll have to take out mortgage insurance.
Most lenders will waive the mortgage insurance requirement if your LTV is less than 80 percent and you have a good history of paying your bills on time.
Although it may be possible to obtain a conventional refinance with only 5 percent equity in your home, most lenders want you to have above 20 percent.
You should speak to your lender about their flexibility with your home refinance if your existing loan is owned by Fannie Mae or Freddie Mac. Traditional refinances can sometimes work with an LTV higher than 80 percent if these programs own your loan and if you’re not trying to perform a cash-out refinance.
There are many options outside of a traditional refinance.
Refinancing with a Home Equity Loan
Another option is to refinance is using your home equity through a home equity loan. Most consumers probably think of home equity loans as additional liens added to their property. However, you can use a home equity loan to refinance your first mortgage, a current home equity loan, or a home equity line of credit. For the group of homeowners who have built up equity, refinancing with a home equity loan could make sense in higher rate environments.
One significant benefit of refinancing with a home equity loan is the difference in closing costs. Traditional refinancing can have thousands of dollars in closing costs. While some home equity lenders do charge closing costs, Discover Home Equity Loans does not having any closing costs, origination fees, or prepayment penalties.
In addition, refinancing with a home equity loan allows you the opportunity to get funds from your home to use for many purposes. One qualifying metric home equity lenders use is closed loan-to-value (CLTV). CTLV is your current mortgage balance plus your desired home equity loan amount, divided by your home value. Discover Home Equity Loans has loan amounts from $35,000-$150,000 with up to 90% of the borrower’s CLTV (in some cases 95%).
So, if you have a $300,000 home with a mortgage balance of $160,000, you may be able to borrow up to $90,000. Your mortgage balance ($160,000) plus loan amount ($90,000) equals $270,000, which is 90% of your home value.
Equity Requirements for Refinancing an FHA Loan
Loans insured by the Federal Housing Administration are often called FHA loans and they allow you to refinance even in dire straits.
The FHA has a program that streamlines loan refinancing if you already have an FHA loan. The good news here is that you don’t need to have an appraisal, and there are fewer hoops to jump through.
FHA streamline refinancing can even occur if you have negative equity. That means your LTV is above 100%, or you’re what would traditionally be called “underwater” on your home. The agency says it’ll help you refinance even if you owe up to twice as much as your home is worth.
FHA loans have a few unique attributes worth considering, if you plan to refinance through the FHA (which is often recommended for homeowners with high LTVs):
- Your loan must be current.
- Cash-out amounts cannot exceed $500.
- Closing costs cannot be added to your loan amount.
- Existing mortgage insurance must be extended to the refinance.
- Lenders have the option to offer “no cost” refinances where they pay closing costs, but they’re allowed to apply a higher interest rate on these types of loans.
Other FHA refinances
- Cash-out refinances can be as high as 85 percent of your home’s value.
- All loans require mortgage insurance.
The big thing to note about FHA refinancing is that you always need mortgage insurance. If you have an LTV below 80%, you will often not need to pay for that insurance with other types of loans. Always ask your lending professional about all of your options. They can help you look for hidden costs, like unnecessary insurance requirements, and tell you how they can impact the total amount you’ll pay over the life of the loan.
What If You Have a Current VA Mortgage?
Loans offered by the U.S. Department of Veterans Affairs (VA) have their own streamlined refinancing option that you can take advantage of, called the VA Interest Rate Reduction Refinance Loan. You may see this designated as an Interest Rate Reduction Refinance Loan (IRRRL).
You’ll need to have an existing VA loan to refinance with a new VA loan, whether or not you use the IRRRL program. This is called a VA-to-VA refinance and it reuses the entitlement you used for the original loan.
Some basic tenants of the IRRRL program include:
- You won’t need an appraisal or credit underwriting when applying.
- There is no mortgage insurance requirement.
- Like the FHA, lenders have the same type of “no cost” refinances.
- The VA says your interest rate may rise if you’re refinancing an existing VA ARM to a fixed rate loan.
- Any VA lender can process an IRRRL application.
- You cannot receive any cash from the loan proceeds, or use it to pay any other loans.
- Most VA loans come with a VA funding fee that is based on your loan type, as well as your military category.
While the VA doesn’t place a limit on the amount you can borrow for a refinance, it does set a cap on how much liability it assumes for your loan. In general, it will cover up to $36,000 per veteran, and lenders generally offer a loan of up to four times this value if you don’t have a down payment. You’ll still need a good credit history and a home appraisal.
You can typically borrow higher amounts and reduce your interest rate by having more equity in your home, having a good credit history and providing a down payment.
Do Jumbo Loans Have Separate Requirements?
A conventional loan is considered “jumbo” when it exceeds limits set by Fannie Mae and Freddie Mac. In most counties and parishes in the U.S., the traditional mortgage cap is about $417,000, so anything larger is a jumbo loan. Limits rise in places where home values are higher and can reach as much as $625,000.
You can see loan limits for your county or parish here.
Each lender will have their own requirements for this type of loan, so there’s no uniform rate, APR, monthly payment or fees that you can expect. That said, many lenders will still want you to have an LTV no higher than 80%, but it isn’t uncommon for some to consider higher LTVs.
In the past, jumbo loans often had an interest rate that was much higher than those associated with conventional loans. This has not been the case in the years following the 2008 housing crisis. The interest rate difference between jumbo loans and conventional loans has lessened since then, but many lenders require larger equity amounts or down payments on jumbo loans.
Making Your Decision
The relative benefits of a home refinance depend on your individual circumstances and your actual debt payments. So, it is best to learn about your home’s equity and LTV before looking at your options. With that information and an understanding of your credit, you should seek out multiple lenders to see what options and rates are available to you.