We have been seeing some welcome appreciation of home values in Seattle and surrounding areas. This means that homeowners now have more equity than they had last year, and this leads to the possibility of some choices—all of which can be beneficial.
You may now be able to use equity to remove PMI
If you made a down payment of less than 20% on your home, you are probably paying private mortgage insurance (PMI). Lenders consider smaller down payments to be riskier for them, so they require this insurance policy to protect them from loss in the event the borrowers could not make their payments. If you paid $400,000 for your home and made a 10% down payment ($40,000), you are probably paying about $130 per month for MI.
You should be able to remove your PMI without refinancing. You’ll just have to show the lender that you have 20% or more equity in the property. That’s usually done by means of an appraisal. If the appraiser says your home is now worth $450,000 or more, you’ll probably be able to drop the PMI—a nice monthly savings.
Equity can also work for a refinance
You may also decide that you would like to put that newfound equity to good use. You have two ways to get cash out of your home’s equity: Sell it or refinance it. Let’s assume you plan to keep your home. This leaves refinancing as the remaining option. Now you have two other choices to make: should you refinance with a loan large enough to pay off your existing loan and give you some cash? Or should you get a Home Equity Line Of Credit (HELOC)?
If you don’t plan to use all the money at once, a HELOC may be your best bet. You’ll be able to pay interest only on the loan during the “draw period” at a rate that is typically set to the Prime Rate, which is currently 3.25%. Expect to pay between 0 and .5% over the Prime Rate.
A HELOC is an adjustable rate mortgage, which means that the rate will fluctuate as the Prime Rate changes. The Federal Reserve is looking for every possible reason to raise rates, so you could reasonably expect the rate for a HELOC to go up .25%-.75% over the next year or so. You should also be aware that after the draw period (the time when you can draw on the HELOC) expires, you’ll begin paying the money back over a 15–20-year term. This would mean a large bump in the required payments, but you would presumably be able to get a new HELOC without too much trouble when that happens.
HELOCs offered by banks are typically easy and cheap to get. They don’t generally charge any significant fees for title, escrow, processing or appraisal, but they may have some sort of annual renewal fee, usually in the area of $100-$250 each year.
Banks will typically allow a total loan-to-value ratio (first plus second mortgage amount as a percentage of the home’s appraised value) of 80%, so if your home is worth $500,000 today and you have a $350,000 loan balance, you would be able to get a HELOC for around $50,000.
You could get the same amount of cash with a cash-out refinance (one loan). That would be a loan of $400,000. You’ll pay a slight rate premium for the cash-out refinance. To give you an idea of the difference, I’ll show you some of the rates we’re quoting today. I’m assuming that you have a credit score of 740 or higher, that you have an impound account for taxes and insurance and that your property would appraise for $500,000.
A cash out refinance for 80% of your property’s value will have a rate about .25% higher than for a loan where did not receive cash at the closing.
Your total payment would be quite a lot lower for the fixed rate loan + HELOC than for the cash-out refinance, but the payment on the HELOC would change over time. If you are concerned about the change in payment as rates go higher, the cash-out strategy would probably be more suitable for you.
Whatever your situation, you should be aware that rates are already beginning to move higher as the economy picks up steam. If your rate is higher than what the market offers today, look into making a move to refinance now; rates are unlikely to move lower. If you have a need for cash from your home’s equity, speak with us about your most effective strategy. But one thing is clear: the time to act is now.