Among the list of the bills individuals pay, mortgage payments are likely to be one people worry about the most. While owning a home is a dream many have, it comes at a cost, and quite a pricy one at that. However, refinancing your mortgage may be an option that works for you. But what is refinancing? When or why should you refinance your mortgage?
Let’s dive in to see how you could benefit from refinancing your mortgage.
What does refinancing your mortgage mean?
When homeowners decide to refinance, this means they will replace their current mortgage with a new one that will pay off the original loan. Refinancing is usually associated with a mortgage that has better terms and lower interest rates. There are types of refinancing that correlate with the purpose or goal for which homeowners are refinancing.
- Rate and term refinancing: The focal point of rate and term refinancing is being able to change your current mortgage with one that has better terms and lower interest rates. While the original balance will not change, the goal that homeowners are trying to accomplish through rate and term refinancing is a lower monthly payment, which can be achieved by securing a lower interest rate or extending the term to a longer maturity date.
- Cash-out refinancing: This typically involves assessing the equity value of your home. Generally speaking, your “equity” is equal to the fair market value of your home, minus the debt you carry on it. If you are wanting to tap into the equity of your home, a cash-out refinance will allow you to apply for a loan that gives you additional cash that can go towards improvements, expenses, etc. A general rule of thumb with cash-out refinancing is that homeowners should have about 20% equity in their home to qualify for a loan.
- Cash-in refinancing: Instead of receiving extra cash, a cash-in refinancing sounds like the name implies – bringing cash in to go towards the mortgage balance. Often, homeowners who do this are trying to lower their loan-to-value ratio. By lowering the loan-to-value ratio, homeowners are able to increase the amount of equity they have in their house in the event that they want to refinance in the future. However, cash-in refinancing can add up to thousands, sometimes making it an expensive option.
- No-closing-cost refinance: Refinance fees can add up quickly, so a no-closing-cost refinance will eliminate upfront expenses that are paid at the closing. Do not be fooled though, those costs did not disappear into thin air. They will be incorporated through a higher interest rate or simply added to the principal balance of the loan, and you will pay it off over the life of the loan. No-closing-cost refinance may be a helpful option if you are not able to part with a lump sum of cash up front.
Why would you refinance your mortgage?
Now that we have covered information about some of the common types of refinancing, you may be wondering when you should consider refinancing. Like with many financial decisions, it is dependent on each individual and their financial circumstances. But here are some factors that may influence homeowner’s decision to refinance:
- Smaller monthly payments: If you extend the length of your loan, you will probably have smaller monthly payments. However the longer it takes for you to pay off your mortgage, the more you will pay in interest.
- Pay the loan off faster: Say you started with a 30-year mortgage, but now you are wanting to turn that into a 15-year mortgage. Paying off a loan faster will mean higher monthly payments but less overall interest accumulated to pay back.
- Switch from an adjustable-rate to a fixed-rate loan: With an adjustable-rate (“ARM”) loan, the initial rate will be fixed for a certain period of time, and then it will change periodically according to a benchmark or index. An ARM is better for people who do not plan to live in a house for a long period of time. A fixed-rate loan tends to be more budget-friendly, as an ARM could become risky if interest rates start rising near the time the loan matures.
- Tap into home equity: Typically with a cash-out refinance, you are tapping into the equity of the home by borrowing more than you owe. The extra cash can be used for various purposes, such as paying off other debt or making improvements to your house.
How do you refinance your mortgage?
Refinancing can save you money if you do it at the right time. However closing costs and fees can accumulate, so calculating the break-even point is important to be able to make the most from choosing to refinance. A mortgage refinance break-even calculator shows you an estimate and gives you an idea of where you need to be in order to break-even. Take into consideration all of the costs associated with refinancing such as closing costs or appraising fees. Here is a quick guide for the process of refinancing:
- Understand your purpose for refinancing: Why are you wanting to finance? What is the end goal for you as a homeowner to refinance? Is it the right time to refinance? Do you qualify based on your financial situation?
- Do your research: Ask for quotes from different lenders and compare them to see which offer would best fit you.
- Apply for a mortgage: It is practical to apply with 3 to 5 lenders and submit your applications within 2 weeks so your credit score will be less impacted.
- Choose a lender and lock in your interest rate: Your chosen lender will evaluate your financial standing by asking for documents for verification. When your interest rate is locked, it cannot be changed within a certain time frame.
- Close on the loan: Your house will be appraised at the request of the lender. Once this has been completed, you can close on the loan.
The Bottom Line - what are the benefits of refinancing your mortgage?
There are many advantages to refinancing your mortgage. Preparation is key to making the process flow more smoothly – do the math, gather the required paperwork ahead of time, and spruce up the curb appeal of your house for the appraisal. Your financial situation impacts your reasoning for refinancing. Refinancing allows you to use your home as a financial tool, as long as you do not end up cancelling out the money you could be saving.
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