Refinancing your mortgage loan can help save you thousands of dollars in interest, lower you monthly payment, pay off your loan sooner, or all three!
Interest rates are increasing but as still at all time lows.
If you have an interest rate above 5% you need to speak to a lender about refinancing before rates go up even further.
In this article we’re going to discuss the pros and cons of refinancing, reasons to refinance, and how to get started.
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2018 Mortgage Refinance Statistics Infographic
What is a mortgage refinance?
When refinancing a loan you’re taking your existing mortgage loan and replacing it with a new loan.
If you have paid down a portion of the original principal balance you could get a much lower mortgage payment.
Refinancing your loan with the lower balance and reamortizing the loan, meaning the 15 or 30 year loan term resets.
1. Lower Your Interest Rate
One of the most common reasons homebuyers decide to refinance their loan is to get a lower interest rate. With interest rates on the rise this year, take advantage by refinancing sooner than later better.
2. Get a Lower Monthly Payment
When you refinance you are getting a new loan and that means a new loan term. If you get a 30 year mortgage, you are resetting the clock and only financing your current balance which is lower than it was originally.
For example: Let’s say you bought your house 10 years ago for $200,000. You used a 20% down payment on a 30 year fixed rate mortgage with a 6% interest rate your payment would be $1,242.61.
Your original balance was $160,000, after 10 years the current balance would be $133,000.
If you refinance to a 4.5% interest rate and a 30 year mortgage your new payment would be $957.22.
3. Refinance out of an Adjustable Rate Loan
If you have an adjustable rate mortgage (ARM) and your interest rate is set to adjust soon then you should refinance into a fixed rate mortgage.
4. Pay Off Your Mortgage Faster
If you want to pay off your loan faster, you could just pay a little more each month that will go towards the principal. However, a 10 or 15 year loan will have a lower interest rate than a 30 year mortgage.
In some cases the rate can be as much as 1% lower, saving you a lot of money and helping you pay off your home even sooner.
5. Remove PMI from an FHA Mortgage
All mortgage require private mortgage insurance if you’re loan-to-value ratio is over 80%. For conventional mortgages PMI will automatically drop off after the loan-to-value ratio drops to 78%.
New FHA rules now require borrowers who put less than 10% down to carry PMI for the life of their FHA loan.
The only way these homeowners can remove PMI is by refinancing out of an FHA loan into a conventional loan.
Once your loan-to-value ratio drops to 78% you should contact a lender about refinancing to drop PMI.
6. Use Your Equity to Get Cash
If you’ve had your mortgage for a while then there’s a good chance you have built some equity in your home. You can get a new loan by tapping into your home equity as collateral.
Cash-out Refinance – A cash out refinance replaces your existing mortgage with a new loan that includes your loan balance plus up to 80% of the LTV ratio. The cash you borrow is included with the mortgage balance allowing you to repay the loan over the term of the mortgage.
Home Equity Loan – A home equity loan also uses your homes equity as collateral but it does not replace your current mortgage. With a home equity loan you’re getting a second mortgage with a separate rate and payment. You can also get a home equity line of credit, or HELOC loan that works similarly to a credit card.
Tips to Refinancing Your Mortgage
Determine if you will Benefit by Refinancing
Refinancing is not free, lenders charge closing costs and other fees. You can expect closing costs to almost as high as when you purchase a house, between 2%-5%.
You need to use a refinance calculator to determine if refinancing will provide a net-tangible benefit.
Check Your Credit Score
Your credit score is the biggest factor in determining the interest rate you’ll receive on a loan. The higher your score, the lower your rate will be.
Improve Your Credit Score Before Applying
The quickest and easiest way of increasing your credit score is by paying down your credit card debt. Your credit utilization ratio is the amount of available credit you’re using.
We recommend paying your balance down to at least 20% if your credit limits to maximize your score.
Get Quotes from up to 3 Lenders
Don’t make the mistake of refinancing your loan with the first lender you speak with.
You should get a loan estimate from at least three different lenders to ensure you’re getting the best deal.
Types of Refinance Loans
Rate and Term Refinance
A refi loan allows you to pay the remaining balance on your mortgage at a lower interest rate and spread the payments out over more years.
The goal is to have a more affordable mortgage payment.
The ideal time to do a Traditional, or rate-and-term refinance is when the interest rates are lower than they were when you originally financed.
This decrease could be due to changes in the prime interest rate, as a result of you building a better credit rating or because you have chosen your lender more wisely.
There may be other times when this type of mortgage refinance is a good idea, too. For example, your expenses may suddenly increase.
You may have large, unexpected medical bills you need to pay or you might take in your elderly parents and incur additional expenses caring for them.
Whatever the reason, if you can make a mortgage refi work, you can ease the burden of too-high mortgage payments.
15 year fixed-rate loan
A 15 yr refinance loan is a good option for people who want to get a lower rate to pay off their mortgage quicker.
A 15 year mortgage will have higher payments than a 30 yr mortgage but in the long run it will save you money.
If the interest rates are low, like they are now, you could save tens of thousands of dollars over the course of the loan by refinancing to a lower rate.
30 year fixed-rate loan
A 30 yr refinance loan is a good option for someone who is looking to reduce their monthly payments.
Refinancing your existing mortgage into a 30 year loan could save you hundreds of dollars a month.
With a cash out refinance you can turn the equity on your home into cash.
You can use the cash to pay off other debts, such as credit card debt, with the additional money over what you owe on the house.
Another option is to take the extra cash yourself to use as you prefer.
There is some risk associated with a cash-out refinance. First, if you are sending the extra cash to pay off credit cards, you are trading those unsecured debts for your secured mortgage debt.
That means that not only do you have to deal with collectors if you miss a payment, but now you also have to worry about losing your home.
At the same time, if you are doing a cash-out mortgage refinance to pay off large credit card balances with high interest rates, you might be able to save money if the mortgage interest rate and term of the loan is advantageous.
Rather than going into a cash-out refi unprepared for possible disadvantages, it is always a good idea to calculate the break-even point and only settle for a refinance loan that gives you a better deal.
A simple form of this calculation is your total closing costs divided by your monthly savings.
Home Equity and HELOC Loans
A HELOC loan, or home equity line of credit is a loan that uses your home as collateral.
You can borrow up to a certain amount and you only pay interest on the amount that you borrow, it is very similar to a credit card.
During the draw period, which is typically the first 5-10 years of the loan, you can repay interest only, or you can pay it off at any time without a pre-payment penalty.
The HARP Program
The home affordable refinance program was created to help homeowners who have little to no equity refinance to get a lower payment.
HARP has low credit score requirements, in some cases a score under 620 can still qualify for HARP.
If you are underwater on your mortgage or have little to no equity, a HARP loan is a great option.
FHA Streamline Refinance
Homeowners with FHA loans can refinance with the FHA Streamline refi program.
This refinancing option allows you to refinance your home more easily.
You do not need to have a credit check or income and employment verification.
The loan goes through more quickly with less hassle for you.
Because there is no credit check you can refinance your home with bad credit.
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Randall has over 15 years of experience in the mortgage and credit industries. He spends a chunk of time helping consumers understand their credit, advise them on how to increase their credit, and lending his mortgage expertise to help them find the right type of loan. Randall lives in Dallas, Texas with his two sons.