Refinancing to Rebuild Home Equity

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Getting a lower interest rate is probably the main reason homeowners refinance their mortgages. But refinancing can also help you rebuild your equity in your home more quickly as well.

If you bought your home prior to 2006, it's almost a sure bet that you've got less home equity than you used to. Unless you live in one of the few high-value, high-demand areas that have largely shaken off the effects of the housing crash, your home is worth considerably less than it was a few years ago and, as a result, you have less home equity.

Rebuilding equity with a 15-year mortgage

The quickest way to rebuild equity through refinancing is by choosing a new mortgage with a shorter term. A shorter term means you're making larger payments each month, so you're paying your mortgage off faster and rebuilding equity at the same time.

The low rates currently available on short-term loans make this option much more affordable than in the past. Interest rates on 15-year fixed-rate mortgages are currently about three-quarters of a percentage point lower than comparable 30-year loans, producing sizeable savings in interest, while 20-year loans have smaller interest savings.

Certain fees are also waived on new 15- and 20-year mortgages if you're refinancing a low- or negative-equity (underwater) mortgage through the federal Home Affordable Refinance Program (HARP), which further boosts the savings.

The 30-year option

If you can't afford the steeper monthly payments of a 15- or 20-year mortgage, you can still build equity faster by refinancing into a 30-year fixed-rate mortgage with a lower rate than your current one. Since the new mortgage will have a lower monthly payment, you can simply continue to make the same monthly payment you're making now on the new loan, and the extra cash will go toward reducing your principle, and therefore increasing your equity.

Benefits of increased home equity

There are a number of advantages to having greater equity in your home. For one, it increases your financial flexibility - if a sudden financial need arises (such as a medical emergency or an unexpected business opportunity) you can borrow money cheaply through a home equity loan.

Having equity also makes it much easier to sell your home if you need or want to. It leaves you with a bit of money for a down payment on your new home and cash to cover the real estate agent's fee and other seller costs. If you're underwater on your mortgage, you'll probably have to bring money to the transaction to sell your home (unless you can arrange a short sale, which is typically limited to those who are seriously delinquent on their loans).

Getting rid of PMI

Building up your home equity also allows you to get rid of private mortgage insurance (PMI) on your mortgage faster than you might otherwise be able to. Since you can have PMI canceled when you reach 20 percent equity, refinancing to a shorter-term mortgage can get you there faster. Since PMI fees are roughly equal to paying an additional half percent in mortgage interest each year, the savings can be significant.

Building equity also brings the day closer that you own your home free and clear. Particularly if you're approaching retirement, not having a mortgage payment to worry about can be a huge benefit.

A few cautions

That being said, refinancing to build home equity more quickly isn't for everyone. First, you want to be sure you can readily afford the higher monthly mortgage payment - you don't want to lock yourself into 15-20 years of scrambling to pay the mortgage each month, or where a temporary setback could cause you to miss a payment.

Financial advisers also caution against locking up too much of your wealth in your home. Before trying to boost your equity, you should be sure that other needs are taken care of, such as fully funding your retirement account, having a four-to-six month emergency fund on hand and having adequate insurance to meet your needs.

But if you've taken care of that, refinancing to rebuild your home equity can be a great financial strategy.

First published on MortgageLoan.com at: http://www.mortgageloan.com/refinancing-rebuild-home-equity-9081



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Personal Finance , Banking and Loans

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