So you have plenty of equity built up in your home. Great! But in most cases, you cannot access that equity until you sell the house. So what should you do?
Today, many Americans are deciding to do a cash-out refinance on their first mortgage. With the financial turmoil from the coronavirus outbreak, bond yields have been dropping, and mortgage rates have headed down.
This is leading to a surge of homeowners refinancing their loans to get lower mortgage payments. In fact, as of early March 2020, 30-year fixed mortgage rates had plunged to just 3.29%. This was the lowest rate that Freddie Mac had recorded in almost 50 years.
If you are interested in doing a cash-out refinance to get a lower rate and access to your equity, you need to know what your Loan to Value (LTV) is and how to calculate it. Below is what you need to know.
Loan To Value Overview and Calculation
LTV is a ratio that assesses the lending risk that a mortgage lender examines before approving a loan. A higher LTV is associated with higher risk. So, if the borrower’s LTV is higher, they may be charged a higher interest rate.
For buyers and refinancers, mortgage companies usually offer the best interest rates to those whose LTV is 80% or lower. Most lenders will not allow the LTV to exceed 80% on a cash-out refinance. Also, some states, such as Texas, prohibit higher LTVs on cash-out refis.
Here is how you calculate the LTV on your property: Divide the current loan balance by the current appraised value. To get an accurate appraised value, the lender will usually require a new appraisal (this will cost you between $300 and $500).
For example, let’s say that you have a home with an appraised value of $400,000, and your current loan balance is $200,000. You have a 50% LTV. You can borrow up to 80% LTV. Eighty-percent of $400,000 is $320,000. Minus what you owe, you can borrow up to $120,000 in your cash-out refi.
Here’s another example: Say you have a house worth $200,000 and your loan balance is $125,000. Your LTV is 63%. You can borrow up to 80% LTV. Eighty-percent of $200,000 is $160,000. Minus what you owe, you can put approximately $35,000 in your pocket at the closing table.
Other Important Factors in a Cash-Out Refinance
Now that you understand what LTV is and how to calculate it, you should be able to determine how much you can borrow in your cash-out refinance.
But what if you are not able to borrow as much as you wanted to? If you need money right now, well, you usually can only borrow up to 80% LTV under current mortgage laws.
If you have some time, however, there are a few things you can do to increase your equity:
- This is going back to when you bought the home….but putting down as large a down payment as you can will give you more equity. And, if you put down 20% or more, you usually can duck paying private mortgage insurance (PMI).
- Make your mortgage payments. Yes, if you want your equity to build, you need to pay all your mortgage payments and hopefully on time to avoid penalties and credit score damage.
- Pay more. If you have a $1,000 minimum monthly payment, try to pay $500 more per month if it does not stress you financially. But ensure that the extra payment is going towards principal and not interest. (Most online mortgage payment sites allow you to make an extra payment specifically toward principal).
- Refinance into a shorter loan. If you can swing the higher payment, refinance a 30-year loan into 15 years. You will pay your mortgage off much faster, and you will be paying more towards the principal each month.
- Do home improvements. Making improvements to the property with cash out raises its value. And you do not have to break the bank to add value. Upgrading the kitchen with granite counters, backsplash, faucet and cabinet refacing might cost you $5,000, but it will add quite a bit to your equity.
Last Things to Know About a Cash-Out Refinance
Do you still want to pull out cash? Here are a few final things to remember:
- Your refinanced home loan replaces your old loan. This means your payments are reset and you are basically starting over with a new loan. That’s why it is a good idea to do a cash-out refinance into a shorter loan if you can handle paying more each month.
- You may have to pay more for longer. Unless you refi into a 15-year loan, you will be making higher payments for months longer.
- You might lower your interest rate. If rates have dropped and your credit is better since you took out the loan, you could enjoy a lower interest rate.
- The interest on your equity could be tax-deductible. If you are using your equity to make a home improvement, the IRS states the interest is tax-deductible.
- Closing costs. Every new loan comes with a few thousand in closing costs. You can wrap them into the loan or pay a slightly higher rate. But the best is to pay them in cash at closing.
Final Thoughts on How to Calculate Cash-Out Refinance LTV
With many Americans’ homes increasing in value and rates at record lows, it is common for people to do a cash-out refinance. But remember that you can only borrow up to 80% of your home’s appraised value. Rates are very low, so the next step is to talk to a good mortgage loan officer in your area and get started on your refi!
- Loan-To-Value Definition. Accessed at https://www.investopedia.com/terms/l/loantovalue.asp
- Good Side Effect of Coronavirus – Refinancing Boom. Accessed at
- Cash-Out Refinances – The Risk of Using Home Equity as Cheap Credit. Accessed at https://www.tsahc.org/blog/post/cash-out-refinances-the-risks-of-using-home-equity-as-cheap-credit
- Steps to Building Equity. Accessed at
- Publication 936, Home Mortgage Interest Deduction. Accessed at