Refinance and save by locking in with a lower rate, that’s what you hear everywhere, but how would you know whether it’s a good option for you?
Your home is worth trying to make sense of it all, and we know that if you make an informed financial decision, for you and your family, you’ll sleep even better.
Below is all that you need to know about mortgage refinancing.
Defining mortgage refinancing
In a refinance you create a new mortgage by revising the terms of your original loan. Don’t fear, you won’t be ending up with two mortgages. Instead, in the process of refinancing a second mortgage is made while the first mortgage is technically paid off.
Mostly by refinancing a mortgage, homeowners want to reduce their interest rate and monthly payments, or even sometimes they want to switch their mortgage provider. However, some individuals do refinance to liquidate equity in the form of cash so that they can buy something they’re dreaming of.
So who can qualify for a refinance?
Usually, every lender’s requirements vary; however, the majority of the lenders want to see that you’ve continued your first mortgage for at least one year before they will consider your mortgage for refinancing. The ideal applicants for mortgage refinancing have at least 3%-20% equity in their houses along with a regular income.
Also, lenders will assess your current income and debt to ensure that your current loan payments will not affect your new mortgage payments. It is commonly known as the debt-to-income (DTI) ratio. Mainly, lenders want to ensure that you earn enough money to cover your current and future bills easily.
Most lenders will also need your credit score, as a credit score can decide the interest rate you will get and if you have a higher credit score, it will mean you’ll get a lower interest rate. However, what if you don’t have a credit score because you never took a loan in the past? Don’t worry a few lenders can utilize the process of manual underwriting to assess your likelihood to pay your loan on time.
When’s a good time to refinance?
The best time to refinance is not when you want to buy a new car with the extra money. Instead, the right time to refinance is when you want to make your less-than-desirable mortgage loan better.
It would be best to refinance your mortgage when you’re under the below scenarios:
- You currently have an interest-only loan
- You currently have an Adjustable Rate Mortgage (ARM)
- You currently have a high-interest rate loan
- You have a mortgage with more than a 15-year term
In each of the above cases, mortgage refinancing could be a good financial move for you, especially if it cuts your payment period or reduces your interest rate.
Your final goal should be to lock in a 15-year fixed-rate mortgage loan that comes with a new payment plan and ideally should be below 25% of your current monthly income.
Try a break-even analysis as it’s the best way to measure whether refinancing makes sense for your current financial situation. It’s an easy decision to refinance if you think you’ll be living in your home long enough to get monetary benefits from the savings by securing a lower interest rate and lower payment.
All you need to do is estimate how long you’re planning to stay in your present house, whether you’ll be living in it until your children complete school or you want to live there forever and retire in the home.
Once you’ve got the answer to the above question, determine how much time it’ll take your monthly savings to break even with the closing costs you are paying with the refinance. Remember, just like your original mortgage there will be closing costs involved in refinancing as well.
What is a mortgage refinance average closing cost?
It usually depends upon some factors, like your lender, the amount you borrow, and even your home’s location. Typically it’s about 3%-6% of the mortgage amount.
A refinance can include application fees, title search, and a new appraisal. That’s why it is very crucial to compute whether the savings justify the up-front costs.
You can avoid those unnecessary costs by asking for a par quote or zero closing cost quotes. By that, your closing cost estimates will not comprise of points or origination fees (1% of the actual loan amount is equal to one point).
For break-even analysis purposes, let’s suppose your closing costs are $4,000 (4%) on your $100,000 mortgage, and you’re able to decrease your interest rate by 1%. With that 1%, you will save $1,000 every year, and it will take you four years to recover your closing costs.
Refinancing from a 30-year to 15-year
There is no better alternative to buying a home with full cash; as “cash is the king.” However, not many homeowners start in the manner. Instead, they go for a 30-year mortgage, thinking that this is the only way possible.
Although, if you have low enough interest rates on your mortgage of 30-years, you don’t need to go through the costs of refinancing to reduce your mortgage term.
In that scenario, try our mortgage calculator and compute as to what your monthly payment might be on a mortgage of 15-year. Then be sure to pay that amount, try setting up an auto-payment feature from your checking account that will withdraw from your funds automatically and before you even know, that payoff balance amount will be fully paid.
If you have a 30-year mortgage with high-interest rates, your best way out is to refinance it to a 15-year term, and your overall savings will be undeniable.
What does refinancing my Adjustable Rate Mortgage or Second Mortgage means?
If you’re going to live in the house for a while, an Adjustable Rate Mortgage (ARM) can cost you a lot. If you currently have an ARM, it’s better for you to refinance it into a fixed-rate loan. It’s worth it even if you have to pay the closing costs as by doing that you’ll avoid the risk of paying high-interest rates when the initial period on the ARM is over.
If you currently have a second mortgage, then it’s a different scenario. Many homeowners who have second mortgages want them to roll it into a refinance of their first mortgage.
However, if your yearly income is double what your second mortgage’s balance is, it will be better for you to pay it off along with the rest of your loan. If your loan’s balance is higher, then refinance it with your first mortgage.
Is mortgage refinancing risky?
Using a refinance to dip into the equity in your home can be extremely risky, financially. Do you want to bet your home to buy a new car? Alternatively, to settle a few credit card debts? Your home equity will be at extreme risk if you want to buy some new things or pay smaller loans, especially if you might face a difficult situation shortly like losing your job or falling into financial difficulties.