What is Mortgage Refinancing?
The process of securing a new loan for your property is referred to as a mortgage refinance. The new mortgage loan pays off the old one when you refinance, leaving you with just one loan and one monthly payment.
People refinance their houses for a variety of reasons. You can employ a cash-out refinance or a rate and term refinance to take advantage of your home's equity or to acquire a cheaper interest rate.
A refinance can also be used to get rid of a co-signer on a mortgage, which is common after a divorce. Rate and term refinancing and cash-out refinancing are the two primary types of refinancing.
A rate and term refinance entails receiving a new mortgage with a lower interest rate and, in some cases, a shorter payment term (30 year changed to 15 year term).
With recent record-low interest rates, converting a 30-year mortgage into a 15-year mortgage may result in monthly payments that are similar to your original loan. This is due to the lower interest rate on your new mortgage, despite the fact that 15-year mortgage payments are typically greater than 30-year mortgage payments.
You can refinance up to 80% of the current value of your house for cash with a cash-out refinance. As a result, it's known as a cash-out refinance. Assume your home is worth $100,000 and you owe $40,000 on your mortgage. As a qualifying borrower, your bank or lender may offer you $20,000 in cash-out, bringing your new mortgage to $60,000.
You should be aware that accepting a cash-out mortgage increases the amount of your lien. This could result in higher payments and/or a longer repayment period.
For many, mortgage refinancing is a great option, helping to lower the interest rate on their mortgage. But you should know that it’s not quite as much of a deal as you might have thought.
How Does It Work?
The procedure for refinancing a mortgage is similar to that for obtaining one in the first place. Although it includes many of the same stages as buying a property, the refinancing process is generally less complicated. It's difficult to say how long your refinance will take, but the average timeframe is 30 to 45 days.
To find the best deal, you usually start by shopping about and comparing interest rates and other terms with multiple mortgage lenders. Then you compare the terms of that offer to the terms of your current loan. If your credit has improved since you were approved for your initial loan, you might be able to qualify for better terms. Keep an eye on the closing costs as you go through this process.
If refinancing your loan with a new lender costs $3,000 up front and your new monthly payment is just $100 less than what you're paying now, you'll need to stay in your house for at least 50 months to make the move worthwhile.
What Should I Ask Before Refinancing?
Here are the main question you should answer before getting a mortgage refinancing:
1. Why Are You Refinancing?
There are a number of different reasons that you could be trying to refinance. After all, if you refinance you might just be able to:
- Consolidate your debt – this works if you have a lot of high-interest debts
- Cash out some extra money – if you need to pay for something you could use the cash
- Decrease the term on your loan – if you lower from a 30-year to a 15-year
- Lock in a rate – if your mortgage is adjustable and you want to make sure you won’t pay higher interest later
- Decrease your payment – if you want to get a lower rate
The key is to know what you’re looking for before you go see the lender.
2. What is Your Credit Score and LTV?
Your credit score is what’s going to get you the interest rate that you’re going to get. If you have even 100 points difference in your score it could dramatically change how much you’re paying for your mortgage, especially over 30 years. It’s all going to depend on how much you take out, of course, but FICO says that you could end up spending thousands of dollars more in interest.
If you had a better score the first time around when you applied for a mortgage you may want to hold off a little while and try to improve your credit score before you attempt to refinance. After all, your credit score reflects your history and as you continue to do good things with credit it’s going to keep improving. Just make sure you know that if you’re getting a mortgage they’re probably going to pull from all of the bureaus, rather than just one or two.
Before you go through the process of applying for a refinance you should also take a look at your loan-to-value ratio. If you owe more than 80% of the value of your house you will likely struggle to get refinancing. That means high LTV is going to get you denied.
For some mortgage lenders, however, you can make a single payment when you apply, that will counter some of the effects of a high LTV. It’s also a way to help them approve your application and works sort of like a down payment when you first purchase.
3. Can I Get a Better Interest Rate?
This is generally the most important factor and what it means is you should have at least a 1% decrease in interest rate from your current mortgage to the possible new one. If you don’t, you may not want to bother about it. Of course, that doesn’t mean that you should always jump at that 1% drop. It depends on how much you currently owe. If you change 1% of $100,000 it’s not going to mean as much as 1% on $1 million.
On the other hand, some people see benefits even if they’re not going to get an interest rate decrease or even if they’re going to get an interest rate increase. That’s because of variable-rate mortgages. For those who have a variable-rate mortgage it might be worth an increase right now to ensure your rate can’t go up again. It’s also possible that you might want the cash that a refinance can get you and that you’re willing to pay more over time.
4. What Are the Associated Fees?
Remember, this is going to be a type of investment for you. You want to look at it from a point of view of how much your return on investment is going to be. Make sure you get a breakdown of all of the fees (an estimate before you jump in) and that you’re comparing these between at least 3 different lenders.
You could end up with closing fees of up to 4% of your mortgage balance, which means that $250,000 mortgage could cost you $10,000. Not to mention you’re going to have to fill out a whole lot of paperwork and it’s going to take up a lot of time, several months in most cases.
When you add up all the fees you could be spending thousands of dollars and while that might be able to be absorbed into the loan you’re taking out, it means you’re going to be paying more over time. It’s also going to increase your mortgage payment, which may make it less desirable. So make sure you know all the costs before you sign.
5. What is the Break-Even Point?
Take a closer look at how much you’re going to be paying to follow through this process and how much it’s going to save you to find out your break-even. You’re looking for the point in time where the benefits are going to outweigh your costs. The way you find that is by dividing the costs of the refinance with the amount that your monthly payment has gone down.
If you reduce your payment by $500 and you have to pay $5,000 to get it done it means you’re break-even is 10 months down the road. For those who plan to move soon, there might not be much of a point to go through this process.
6. Do You Have Enough Equity?
When you make a payment on your mortgage you’re building equity. The more equity you have the better it is for you and if you have at least 20% equity then you’re in a good spot to start the process of refinancing.
For those who haven’t had the house long or who didn’t make a large down payment it’s possible that you don’t have much for equity. If you have a loan such as an FHA Streamline refinance, VA IRRL or HARP you may not have to worry about equity to get a refinance.
7. How Long Until You Move Again?
If you’re going to start seeing benefits within a short period and you’re planning to stay in the same home for at least that long you might be able to reduce the amount of money that you have to pay over time. That’s going to help you in the future.
For those who plan to move soon, it might not be a good idea because you don’t have a lot of equity and you’re not getting a whole lot of adjustment to your balance, especially the more frequently you refinance.
Remember, you want to get the benefits and when you move frequently and refinance you could end up with more costs than you save.
8. Do You Have Large Expenses Coming Due?
Pay close attention to the other debts that you have right now and whether it’s really going to be a good idea to pay them off with a mortgage refinance. You may be able to consolidate debts into your new mortgage, based on the equity in your home. After all, you’re going to be spending a lot less in interest on your mortgage than any other debt you have.
If you’re going to be paying a lot of money for something in particular in a short time frame you may also want to look at using the money you get from your refinance to cover the expense.
9. Am I Ready For Appraisal & Underwriting?
Before you refinance, you must get an appraisal, just like when you bought your house. Your lender orders the appraisal, the appraiser comes to your home, and you get an estimate of the value of your home. You'll want to make your home appear its best in order to prepare for the appraisal. To make a good first impression, clean up and make any minor repairs. It's also a good idea to make a list of home improvements you've made since you've owned it.
Once you submit your application, your lender begins the underwriting process. During underwriting, your mortgage lender verifies your financial information and makes sure that everything you’ve submitted is accurate. Your lender will verify the details of the property, like when you bought your home. This includes an appraisal to determine the home’s value. The refinance appraisal is a crucial part of the process because it determines what options are available to you.
If you’re refinancing to take cash out, for example, then the value of your home determines how much cash you can get. If you’re trying to lower your mortgage payment, then the value could impact whether you have enough home equity to get rid of private mortgage insurance or be eligible for a certain loan option.
The underwriting is complete if the home's worth is equal to or more than the loan amount you wish to refinance. The details of your closure will be communicated to you by your lender.
When you refinance you may be able to save thousands of dollars in interest and you may even be able to decrease the time frame for your mortgage, but you need to pay attention when you do. Look at the costs and what your plans are to make sure you’re making a smart decision on your home.
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