When you borrow money to buy a house, the bank typically will not provide financing unless the house is worth the amount borrowed or less. Fortunately, there are still options for people who want to refinance a home that's underwater or who want to finance both the purchase and the renovation of a home.
What Is a Mortgage?
A mortgage is a security interest in a piece of real estate. When you borrow money to buy a house or refinance a house, you give the lender a mortgage, which means that if you don't pay the loan back, the lender can foreclose on the mortgage and sell the property to satisfy the debt. Lenders do this because home loans are such large loans, and they need to protect themselves in the event that you don't pay.
Home Equity Loans and HELOCs
A home equity loan is a type of mortgage you can take out on a property you already own. If the property is worth more than you owe on it, the difference is the equity, and you can borrow up to the amount of the equity and pay a mortgage to the home equity lender.
A home equity line of credit, or HELOC, is a home equity loan that allows you to borrow up to a certain amount by taking draws from the loan.
Loan to Value Ratio
When deciding to provide a mortgage loan, the lender will look at something called loan-to-value ratio, or LTV ratio, which is the ratio of your property's value to the loan amount. For example, if your house is worth $100,000 and your mortgage balance is $90,000, you have a 90 percent LTV. The lower the LTV, the more protected the mortgage lender is, so most lenders prefer a low LTV and want your house to be worth more than you owe them.
LTV and Conventional Mortgages
You can get a conventional mortgage with up to 97 percent LTV; that is, you can borrow up to 97 percent of the home's value and put down only 3 percent. However, conventional mortgage lenders will require you to pay private mortgage insurance (PMI) every month until you make enough mortgage payments to bring that LTV below 80 percent. You can avoid paying PMI by putting up a down payment of at least 20 percent.
LTV and FHA Loans
FHA-backed mortgage loans also allow borrowing with a low down payment, but you won't get charged PMI for putting down less than 20 percent. However, FHA loans have their own mortgage insurance that all borrowers must pay regardless of down payment. You may also have to pay higher interest and additional fees.
LTV and VA Loans
If you're a veteran and take out a VA loan to buy a house, you can get the loan with no money down at all. Like an FHA loan, the interest rate may be higher, and you may have to pay more fees.
Refinancing Options for Underwater Mortgages
If your house is worth less than the balance due on your mortgage, your home has negative equity. You may hear people say that your house is "underwater." In that case, if you want to get a refinance for a better interest rate or a lower payment, you're trying to borrow more than your house is worth.
Freddie Mac has a product called the Enhanced Relief Refinance Mortgage. If you applied for the refinance loan after November 1, 2018, you may be able to borrow more than your house is worth. If you have an adjustable rate mortgage, you can borrow up to 105 percent of the home value; if the loan is a fixed rate loan, there are no LTV limits.
Financing the Purchase and Renovation
Some mortgage lenders have special programs for people who want to buy a fixer-upper but also need to borrow money for the renovations. With those types of loans, the lender will have the property appraised and allow you to borrow more than the current market value to finance repairs up to a certain threshold. For example, many lenders offer FHA-backed purchase and renovate loans called 203(k) loans.
These loans are available for the purchase and renovation of homes that are at least one year old and need repairs of at least $5,000. A 203(k) loan allows you to borrow enough to buy the property, plus enough to rehab the home (but you can't borrow more than 110 percent of the appraised value in any event).
- Debt.org: How Much Home Equity Can I Borrow?
- Freddie Mac: Enhanced Relief Refinance Mortgage
- Bankrate: Refinancing with the HARP Mortgage Replacement Programs
- Experian: What Is Loan-to-Value Ratio and Why Is It Important?
- Quicken Loans: LTV: Loan-to-Value Ratio Explained
- U.S. Department of Housing & Urban Development: 203(k) Rehab Mortgage Insurance
Rebecca K. McDowell is an attorney focusing on creditor and debtor law. She has a B.A. in English and a J.D.