A mortgage refinance will replace your current loan with a new one. Many times, people decide to refinance to reduce their interest rate, tap into home equity, or lower monthly payments.
Mortgage refinance applications are a significant portion of all mortgage applications. The relatively low-interest rates have persuaded homeowners to reorganize their loans and finances. Whether or not a mortgage refinance is right for you will depend more on individual circumstances instead of just the rates.
Everything About Mortgage Refinance
Before everything, it is very important to know when is the right time to refinance your mortgage. And keep these things in mind before you decide if a mortgage refinance is right for you.
Home Equity, Credit Score, Taxes and Your Debt-to-Income Ratio
The first qualification you will need in order to refinance is your home’s equity. Many home values have been on the rise and the share of underwater homes has dropped. However, some homes haven’t regained value. You may not be able to refinance with little or no equity with a conventional lender. But there are some government programs available. The best way to find out if you qualify is to visit with a lender and then discuss your individual needs. If you have at least 20% equity, it can be much easier to qualify for a new loan.
Credit Score: Lenders have tightened standards for loan approvals. So you may be surprised to find that even if you have good credit, you don’t necessarily qualify for a low-interest rate. In order to qualify for some of the lowest interest rates, you need a score of 760 or higher. If you have a lower score, you can still qualify for a new loan but the fees or interest rate can be higher.
Debt-to-Income Ratio: If you have a loan, you may think that you can easily get another one. However, lenders have also become stricter when evaluating the debt-to-income ratio. If you have substantial savings, a stable job history, or a high income, it can be easier to qualify for a loan. Lenders want to keep the monthly housing payment under 38% of your gross income. You may want to focus on paying off some debt before your refinance in order to qualify.
Rates vs The Term
You don’t want to just focus on the interest rate but also establish some goals when refinancing to determine which product meets your needs. If the goal is to reduce monthly payments then you want to choose a loan that has the lowest interest rate for the longest term. Maybe you want to pay less over the length of the loan. Then look for the lowest interest rate at the shorter term. If you want to pay off the loan as quickly as possible then look for an option with a short term and payments that you can afford.
Liens or a Second Mortgage: If you have liens or a second mortgage then refinancing can be a challenge since the new loan is used to pay off the first mortgage. You want to resolve any liens or tax liabilities before you begin the refinancing process.
The Cost of Refinancing, Taxes, Break-Even Point and Insurance
Refinancing a home isn’t free. However, you can find different ways to cut down on the cost or wrap the cost into your loan. Some lenders have a “no-cost” refinance option. This means you pay a slightly higher interest rate in order to cover the closing cost. Don’t forget to shop around since some refinancing fees can be reduced or paid by the lender.
Taxes: Many people rely on the mortgage interest deduction to lower their federal tax bill. If you refinance and are paying less interest, your tax deduction could be lower. Very few people think of this as a reason not to refinance but it’s still something to keep in mind.
Your Break-Even Point: One calculation that plays into your decision is the break-even point. This is the point at which the costs of the refinance are covered by what you save monthly. If the refinancing costs you $2,000 and you are saving $100 every month then it takes you 20 months to recoup those costs. If you plan to sell or move within those two years then a refinance doesn’t make sense.
Private Mortgage Insurance: If you have less than 20% equity in the home, when you refinance you will have to pay private mortgage insurance. If you are already paying this, it shouldn’t make a big difference to you. If the home value has decreased since the purchase date then you may need to pay PMI for the first time. The lender you are working with can help you calculate whether you will need to pay this and how much it adds to your monthly payment.
Why You May Want to Refinance
There are a number of reasons why a mortgage refinance may make sense to you.
Reduce the Monthly Payment and Pay Off the Loan Faster
If your goal is to pay less each month then you should refinance with a lower interest rate. You can also reduce the payments by extending your loan term but with this option, you will pay more interest in the long run.
If you refinance from a 30-year mortgage to a 15-year one then you can pay off your loan in half the time. Due to this, you would pay less interest over the life of the loan. There are pros and cons to a 15-year loan but one of the reasons why more people don’t choose this option is because your payments usually go up.
Get Rid of Private Mortgage Insurance and Avoid Balloon Payments
Get Rid of Mortgage Insurance: One of the top mortgage tips is to eliminate this when you can. Private mortgage insurance on a conventional home loan can just be canceled. But if you have an FHA loan then the mortgage insurance can’t be canceled. The only way to get rid of the insurance is to sell the home or refinance once you have enough equity.
Balloon programs like adjustable-rate mortgages seem like a good option for lowering the monthly payments and rate. However, at the end of the term, if borrowers still own the property then the mortgage balance can be due, which can be a lot. A refinance can allow you to avoid these balloon payments and instead continue on with affordable monthly payments.
Equity and Fixed-Rate Loan
Use equity, when you refinance to borrow more than you owe on the current loan. Your lender will give you a check for the difference This is called a cash-out refinance. Some people can get a cash-out refinance and a lower interest rate at the same time.
Switch from an Adjustable-Rate to a Fixed-Rate Loan. Interest rates on an adjustable loan can go up over time but the fixed rate stays the same. When you refinance into a fixed loan, you can have more financial stability and more steady payments.
When you get a cash-out refinance, you can have cash in hand to spend on debt consolidation, financial needs, or home improvements. You need to have built up equity in your home. You aren’t able to pull out 100% of your home’s equity but you can pull out some. For example, if the home’s value is $200,000 and the balance is $100,000, you can refinance the $100,000 loan for $150,000 and then have $50,000 for renovations.
This type of refinancing may give you a lower interest rate if you bought the home when mortgage rates were higher. If you want to lock in the lower interest rate and don’t need cash then you can go ahead with a traditional refinance.
Good Things About Cash-out Refinance
A cash-out refinance can make sense for a few reasons:
- Debt Consolidation: You can use the money to pay off your high-interest credit cards and save yourself money in interest
- Higher Credit Score: When you pay off your cards, you can build your credit score since you lower your credit utilization ratio
- Tax Deductions: The mortgage interest deduction may also still be available on this type of refinance if the money is being used to improve the home
- In addition to the benefits, there will be some cons that you need to consider for this type of mortgage refinance
- Foreclosure Risk: Since the home is used as collateral you are risking it if you aren’t able to make payments. If you are doing a cash-out refinance to work on paying down your credit cards then you end up paying for unsecured debt with a secured debt
- New Terms: Your new mortgage has different terms so you want to make sure you check your fees and interest rate before you agree to the new terms
- Private Mortgage Insurance: If you borrow more than 80% of your home’s value then you have to pay for private mortgage insurance
- Enables Bad Habits: Using a cash-out refinance to pay off credit cards can backfire if you rack up debt again and don’t have this option to pay off the balance
When Can You Refinance the Home?
Most lenders and banks require that you maintain the original mortgage for at least a year before you are able to refinance. However, each lender and the terms are different. Don’t hurry, shop around and see which lender has the best offer for you. It’s recommended to check with your specific lender to see any details or restrictions. In many cases, it would make sense to refinance with your original lender but it’s not required. It’s easier for a lender to keep a customer than get a new one so some lenders don’t require a property appraisal or a title search if you are sticking with your current lender. Many will offer a better price to a borrower looking to refinance. You may be able to get a better rate when you stay with your original lender. But you still want to shop around just to make sure.
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The Cost of Refinancing
Refinancing does come with some costs, just like with a typical house mortgage.
Application Fee: Lenders have this charge to cover their cost of checking your credit report and the initial cost to process your loan request.
Title Search and Title Insurance: This charge covers the cost of the policy and insures the policyholder for a specific amount. It covers any loss caused by discrepancies found in the property title. And covers the cost to look at the public records and verify the ownership on the property.
Attorney Review Fees: The lawyer or the company that conducts the closing charges the lender for fees and, in turn, the lender charges those to you. Borrowers may also be required to pay for other legal services and fees related to the loan.
Fees and Points Incurred in Loan Origination: Lenders will charge an origination fee for the work in evaluating and preparing the loan. Points are prepaid financial fees imposed by the lender at the time of closing.
Risks of Refinancing
A mortgage refinance can be a smart move but it’s not beneficial for everyone. Refinancing can be a risk if you aren’t able to lower the interest rate by that much or you incur a lot of fees.
Refinancing Isn’t Free: Your mortgage refinance comes with costs, such as origination fees, title insurance, taxes, and an appraisal. Just like your original mortgage. Even if the refinance comes with a lower monthly payment, you aren’t actually saving money until the monthly savings make up for the cost of refinancing. It’s helpful to do the math ahead of time and use a refinance calculator to see how many months it takes to reach this point. If you are even thinking about moving before then, this it’s not worth it.
Prepayment Penalty: Some lenders may charge you extra for paying the original loan amount off early. A high prepayment penalty may persuade you to stick with your original mortgage instead of refinancing.
Total Financing Can Increase: If you refinance to a new 30-year mortgage then you will pay more in fees and interest over the life of the loan than if you have kept the original mortgage.
Reasons Not to Refinance
One of the main reasons to not refinance is if you are going to be moving soon. You need to consider your break-even cost and know that it usually takes a year or two to break even on the cost of a refinance. If you will be considering moving then it’s not worth it.
If you are close to paying off your mortgage then it may make sense to wait instead of a refinance. This is true even if the terms of the refinance are better than the current terms. By refinancing, you might extend the term of the loan and increase the cost, which means that refinancing may not be worth it in the long run.
If you are having financial problems then you may want to reconsider. Refinancing may seem like a good way to consolidate debt but in some situations, it puts you at risk for further financial problems.
Step-by-Step Process to a Mortgage Refinance
If you are ready to tackle the mortgage refinance process, here are the steps you want to take:
- Set the goal. Whether it’s lower payments, a shorter loan term, or getting rid of the insurance, knowing why you want to refinance is an important step
- Start shopping around for the best refinance rates. In addition to looking at interest rates, you also want to look at the fees. When you shop mortgage lenders, you can be sure to get the best deal
- Apply with different lenders. You want to get information from about three to five lenders but apply within a two-week period so you can minimize any impact on your credit score
- You need to choose a lender after you have compared the loan estimate documents you receive. The loan estimate also tells you how much cash you need for any closing costs
- Lock in your rate. When you do this, your interest rate can’t be changed during a specific period. You and the lender then try to close your loan before this expires
- Close on your loan. During this time, you pay the closing costs listed in the closing disclosure. Closing on a mortgage refinance is very similar to closing on your purchase loan but no one is handing you keys at the end of it
About this second step, maybe we can help you. Try here to find the best options to refinance your mortgage loan. Put in your information below and see what suggestions you will get. Good luck!
A mortgage refinance can be a great option for you if you are trying to lower your monthly payments. And eliminate your mortgage insurance, tap into the home’s equity, or pay off your home early. There are plenty of things to consider before you start the refinance process. Consider your credit score, your financial situation, and if it really makes sense to go through the refinance process. You want to make sure you have goals in mind when starting the process since refinancing is not free and you will have to pay some closing costs.
There are certain situations where refinancing doesn’t make sense and you want to consider all your options. When you are ready to start the mortgage refinance process, know that the process is similar to getting an original mortgage and you want to shop around for the best rates.
Kevin Strauss is a personal finance writer and homeowner based in the Los Angeles area. Being in one of the most expensive markets in the country, he’s learned to maximize resources to plan for both his monthly expenses and future financial needs. Kevin has a passion for helping those in a similar situation navigate the complex world of personal finance so they can pay down debt, plan for the future and live out their dreams. In addition to covering personal finance in depth on Loanry.com, Cashry.com, Debtry.com, Budgetry.com, Billry.com, Creditry.com and Taxry.com. Kevin shares his expertise with readers who want to create budget-friendly habits across the web.