How, when and why to refinance your home loan to lower your mortgage payments or access equity.
Refinancing Your Mortgage
In today’s low-interest environment, refinancing a mortgage can not only save you money but also potentially help homeowners access the money they have built up in their homes. Before going through the process, it’s important to understand how it works, how your credit affects your rate and what you can do to get the best possible outcome.
A mortgage refinance can help lower your monthly payments or unlock the cash in your home to consolidate debt, start a remodeling project or take a dream vacation.
Some of the cons include high out-of-pocket fees, closing costs, pushing your break-even point further away or potentially going underwater from taking too big of a loan.
Before you start on a mortgage refinance, set a goal for your refinance, understand your credit and talk to multiple lenders to get the best possible rate.
What Is a Mortgage Refinance?
A mortgage refinance is the act of rolling over your current mortgage into a new home loan. During this process, your home loan provider will assess your home’s current market value, go through your credit and tax return history and verify your credit. If everything is successful, your home mortgage lender will present you with several options to lower your monthly payment, take equity out on your home or reduce the number of years on your home loan.
Refinance Savings for a $300,000 Mortgage
Payments Over 10 Years
Why Should You Refinance Your Mortgage?
There are several reasons why homeowners consider refinancing their mortgage. The biggest reason is to save money on their monthly payment. You can do this through a refinance by moving to a lower interest rate or by eliminating your private mortgage insurance (PMI) payment from the loan amount.
Another reason to consider a mortgage refinance is to unlock some of the equity you have built into your home. You can use the money to pay off high-interest debt — like credit cards or personal loans — or invest it back into your home through remodeling projects.
Refinancing can also help you reduce the amount of time you will be paying your home loan. By shaving years off your mortgage, you can unlock more equity faster or walk away with more money if you decide to sell your home.
If you are curious about how you could save money, a mortgage refinance calculator can help you compare the costs and benefits of refinancing.
Completing a mortgage refinance at a lower rate can help you reduce your monthly payment. Refinancing from a 6% interest rate to a 3% interest rate can put over $4,000 back in your pocket every year.
Benefits of Refinancing Your Mortgage
There are numerous benefits to refinancing your mortgage. While most of them revolve around reducing your monthly payment, a new mortgage can have a shorter term, stabilize your payment with a fixed interest rate or help you use the equity you have built up in your home. These are the most common reasons homeowners decide to refinance:
- Reduce your payment through lower interest: If your current interest rate is higher than today’s rates, you could save money through refinancing. For example: Refinancing a $250,000 mortgage to lower the interest rate from 6% to 3% would save over $400 per month on interest and principal payments alone.
- Reduce your payment by eliminating PMI: Purchasing your home with less than a 20% down payment means you will probably pay private mortgage insurance (PMI) on top of your principal and interest. Refinancing once you have 20% equity built-in can cut out the PMI payment, unlocking even more savings every month.
- Shorten your mortgage length: If you are considering selling your home or want to get out from under monthly payments, shortening your mortgage length can help you get the most from your home. Converting from a 30-year mortgage to a 15-year home loan helps you build your equity faster, resulting in more options for your home.
- Converting to a fixed rate: While adjustable-rate mortgages (ARM) are great for the initial term of 3–5 years, the monthly payment can spike once it’s over. Refinancing an ARM can put you on a fixed rate for 10, 15 or 30 years. This means you’ll know what your monthly payment is every month, allowing you to build a balanced budget for your home.
- Take cash out from home equity: Are you considering remodeling your home, paying off high-interest credit cards or going on vacation? Your home can help you get the money you need to achieve those goals. If you have over 20% equity in your home, you can use a cash-out refinance to borrow against your equity to cut down on bills, invest in the value of your home or go on that once-in-a-lifetime trip.
In most cases, homeowners can refinance their homes at any time to take advantage of savings or draw some of the equity for other use. Before signing any papers and making it official, it’s critical to understand all the costs of refinancing. These include going over your credit profile, understanding your credit score, finding the refinance quote that reflects your best options and determining how much you will pay in upfront costs.
Costs of Refinancing Your Mortgage
While several positives come with refinancing your mortgage, it also comes with some costs which need to be considered. Closing payments, prepayment penalties and a longer break-even point can all outweigh the potential benefits of taking out a new mortgage.
- New closing costs and fees: Before you can finalize your new loan, you will be responsible for paying for several refinancing costs. This includes closing costs and fees for items like home inspections. Even though you can add some of them to the loan, it will affect your monthly payment and could erode your savings.
- A lower rate could have higher fees: Getting the lowest interest rate often requires paying “points” towards your loan. This means you will need to pay cash out of your pocket to lock in your loan.
- Prepayment penalties: Some mortgages may have prepayment penalties, meaning you’ll pay more if you decide to reduce your balance early. Be sure to understand the terms and conditions before closing.
- Longer break-even point: Extending the life of your home mortgage by several years could put your break-even point further out in the future, depending on how long you intend to live in your home. It’s important to use a refinance calculator to understand your total savings and when you can actualize them.
- Underwater loans: If you take out too much money, you run the risk of having a mortgage that is more than your home is worth. Known as “going underwater,” it’s important to understand the actual market value of your home before signing loan documents.
How to Refinance Your Mortgage
Refinancing a mortgage shouldn’t be a quick decision. After weighing the pros and cons, you can determine your goals and take the necessary steps toward lowering your payment or taking cash out to achieve your financial goals.
Set a Goal for Your Mortgage Refinance
Before starting toward refinancing, it’s important to set a goal for starting a new mortgage. Are you interested in saving money on your monthly payment? Or is taking out cash to consolidate debt or fund a big project more important? By setting a clear-cut goal, you can decide the best way to move forward with a refinance.
Check Your Credit Score
As with any transaction involving credit, you should know your credit score before talking to lenders. Checking your credit report can help you understand how lenders perceive your risk, and it allows you to fix any erroneous information before requesting rates. Although you can refinance with bad credit, you may not qualify for the best rates.
Shop for Mortgage Refinance Rates With Multiple Lenders
Once you understand your credit, you can now shop for mortgage refinance rates with several lenders to see which gives you the best options. You can request multiple quotes from lenders within 14 days of your first request without negatively impacting your credit. If you qualify for a VA mortgage refinance or FHA mortgage refinance, you will want to work with lenders who can help you explore those options.
Select a Mortgage Refinance Lender and Lock Your Refinance Rate
Once you’re satisfied that you’ve found the best option, it’s time to “lock” your rate with the lender. It’s important to lock as soon as you’ve made your decision because mortgage rates change daily, and each day you don’t lock could mean a higher rate. Some lenders will allow you to “float down” if there’s a lower interest rate after you close, but it may come with an additional fee.
Prepare to Close Your Refinanced Loan
Once you’ve locked, your lender will start the closing process. Just like with purchasing your home, you will have to go through all the paperwork, including income verification and submitting tax return information. Depending on the specifics of your refinance, you may also need to have your house appraised, which can cost upwards of $400.
Attend the Mortgage Refinance Closing
At the final step, you can sign your closing paperwork and take full advantage of your refinance. Just like your first closing, your lender will tell you where to go and what you will need to provide. Be prepared with a government-issued photo ID and the cash required to close. You can also wire transfer the cash to the bank in advance.
Expert Insight on Mortgage Refinancing
To help answer all your questions, MoneyGeek spoke with industry leaders on refinancing and home lending. This panel will help you identify what to look for, when you should consider refinancing and how to avoid scams in the process.
- Why is the current market ideal for homeowners to consider a mortgage refinance?
- What questions do homeowners need to consider before refinancing?
- What should homeowners look for when comparing refinance offers?
- How can homeowners protect themselves from refinance scams?
Senior Economist and Director or Forecasting at the National Association of REALTORS®
President and CEO of University Credit Union
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