How much equity do I need to refinance?

There are many reasons why you might want to refinance your mortgage - to get a better interest rate, access your equity to fund a project, consolidate debt, or change your loan terms to better suit your changing personal and financial circumstances.

No matter why you want to refinance, it’s important to consider the value of your home when you’re weighing up your options. If you have less than 20% equity in your property, you may need to pay Lenders Mortgage Insurance (LMI) when you refinance. 

What do lenders look at when I refinance my mortgage?

If you approach a lender wanting to refinance your home loan, they’ll typically value your property as part of the assessment process. This is to get an accurate picture of your loan-to-value ratio (LVR) and assess their risk as a lender.

Your LVR is the current value of your property compared to the size of your loan, expressed as a percentage. LVR is calculated by dividing the loan by the property’s value. For example, if the home loan is $480,000 and the property is worth $600,000, the LVR will sit at 80%

In most cases, the lower the LVR, the lower the risk to a potential lender, and vice versa. Bear in mind that since LVR is based on an individual valuation, it may differ from lender to lender.

What is my home’s value?

How much your home is worth today may not be the same as when you bought it. Depending on the real estate market in your area, it could have increased or decreased in value, slightly or significantly.

As a result, your equity (the difference between the current value of your home and the amount still owed on your loan) will have also changed. Your equity can affect your chance of refinancing, so it may be worth estimating how much you may have.

If your property is now worth more than it was when you first took out your mortgage, your LVR will be lower, meaning you have more equity and greater borrowing power. This puts you in a better position to refinance your home loan and borrow more at lower rates with lower repayments. 

If your property is now worth less than what it once was, your LVR will be higher, meaning you have less equity and reduced borrowing power. This can put you at a disadvantage as you typically won’t qualify for the lowest interest rates on the market, meaning you may end up paying more interest over the life of your loan. 

If the value of your property has dropped so much that it’s below your outstanding home loan amount, you’re in what’s called negative equity. If you find yourself in this position, refinancing generally isn’t recommended until your equity is back in the positive range.

Can I refinance a home loan without equity?

Having low equity in your home doesn’t mean that you can’t refinance your home loan at all. However, it can limit your options and add to your costs. This means that you might have to pay for lenders mortgage insurance (LMI), regardless of whether you’ve paid it before. 

Refinancing is easier when your loan to value ratio (LVR) is under 80%, much like how it’s usually easier to have a 20% deposit when applying for a standard home loan. Having at least 20% equity in your home makes it easier to refinance, as it reduces the lender’s financial risk. 

If you have no equity or negative equity in your home, you may find it challenging to refinance your home. However, it might be possible to refinance with as little as 5% equity in your home by paying for LMI. But you need to consider the amount of the LMI premium as it can run into several thousand dollars and add to the cost of your loan. It’s worth comparing your potential savings to your refinancing costs to check whether refinancing may be a good option for you or not. 

You can also consider refinancing with a specialist lender, which may have more lenient eligibility criteria around home loan serviceability. If you have good credit and can demonstrate regular income and adequate savings, a specialist lender might allow you to refinance with minimal equity in your home. 

Talking to a broker might be a good idea as well. An experienced broker will guide you and help you assess your options. They can then introduce you to lenders who are more likely to lend to borrowers in situations like yours. If refinancing is not an option, your broker may be able to help negotiate a better deal with your current lender, which could reduce your interest rate.

Another alternative is getting a family member to guarantee your loan to boost your borrowing capacity, but this comes with its own risks to the family member and their finances. 

What can I do about negative equity?

Any homeowner whose property declines in value can experience a drop in equity. As house prices fall in Australia, lower equity is more probable for homeowners, making it even more crucial to understand how much you have, where you stand on the LMI threshold, and whether refinancing makes sense.

If you’re dealing with negative equity, your chances of refinancing are extremely slim. Having a loan that’s higher than the value of your property is often deemed too risky for lenders and any applications will more than likely be declined.

There are several strategies that could help turn your equity around and take it from negative to positive, including:

Pay off more of your home loan

Paying off more of your mortgage can help you build up your equity. Increasing your repayment amount, making extra repayments, and increasing your repayment frequency can all help you chip away at your home loan sooner.

Renovate to raise your property’s value

Another way to up your equity is by adding value to your home by way of renovations. Whether it’s upgrading your kitchen, bathroom and outdoor space, constructing an extra bedroom or granny flat, or adding ample space for storage, renovations can significantly increase how much your property is worth.

Before you pick up any tools, be sure to do plenty of research and consider what renovations will have the most impact on the value of your property, so it’s worth the time, effort and investment. You may also need to consider how you’ll be paying for your renovation, such as using a home improvement personal loan – just be wary of spending too much and overcapitalising.

Avoid redrawing from your mortgage

If you have a redraw facility as part of your home loan and have contributed extra repayments in the past, try to leave the funds where they are. This will ensure your loan balance is going down rather than up.

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