When deciding whether to refinance your home, or not.
There are many advantages and disadvantages when refinancing you must consider.
For some, the pros out-weigh the cons and refinancing is a clear choice.
For others, there are far too many disadvantages for it to make sense.
In this article we are going to explore the pros and cons of refinancing your home to help you better understand when the right time to refinance your home is.
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What does it mean to refinance?
A mortgage refinance is when you take your mortgage loan and refinance it into a new loan with new terms. Refinancing is commonly done to get a lower mortgage payment, reduce interest rates, and to save money.
There are a few fees lenders charge when you refinance your mortgage loan. Because of these fees you need to throughly understand all aspects of the terms of the new loan to determine the actual benefit refinancing your home brings you.
Pros to Refinancing
- Get lower interest rate
- Lower monthly mortgage payment
- New loan term
- Cash out home equity
- Drop mortgage insurance
Cons to Refinancing
- Closing costs
- Upfront fees
- Long application process
- Using funds for debt consolidation desired debt with your home
Closing costs on a refinance are similar to the fees charged with a new mortgage. You will pay loan origination fees, home appraisal in some cases, and other fees that can add up to 1%-3% of the loan amount.
In order to determine the net tangible benefit you will receive by refinancing your home you need to calculate your savings and compare it to the refinance fees.
For example: If you have a $200,000 mortgage with a 5% interest rate and you refinance to a 4.5% mortgage rate. This equates to a $60 monthly reduction in your mortgage payment and $22,000 in total savings over a 30 year loan.
If you’re charged $3,000 in total refinance fees it will take you 5 years before you will start saving money. In this scenario it’s probably not worth it.
Home Equity Loans
Home equity is the amount of money you would pocket if you sold your home at market value after paying off your loan. If you have at least a 30% equity stake in your home (70% loan-to-value ratio) then you may qualify to use your equity as collateral for a loan.
Home-equity loans, or HELOC loans are a second mortgage on your home. Homeowners get second mortgages to help pay for home repairs or for remodeling. The benefit of these loans is being able to access the equity in your home to get the cash you need when you need it.
Unfortunately a major drawback of these loans is that you will be losing equity in your home. When deciding weather or not to get a home equity loan there are many pros and cons to consider.
Pros of Home Equity Loans
- Convert your equity into cash
- Get money to make home repairs
- Increase your home’s value with renovations
- Pay off debt
- Lower interest rate than personal loans
Cons of Home Equity Loans
- Reduce your equity
- Loan is secured by your home
- Foreclosure possible if loan is not repaid
- Higher interest rate than a mortgage
Cash-out refinancing is similar to a home-equity loan. However, instead of getting two loans, the borrower refinances the entire current mortgage with the new lender, plus cashes in on some of the equity.
The benefit of getting money out of your home this way is that you have a single repayment to one lender and the interest rate is lower than with home equity loans. Credit score requirements are also lower for a cash-out refinance because there is no second lean holder on your home.
Because home equity loans with bad credit are difficult to qualify for, cash-out refinancing is a great alternative option.
A streamline refinance is a program offered for Government backed mortgages to quickly reduce interest rates and mortgage payments. FHA loans are the most popular type of streamline refinance used. But VA loans and USDA loans also have a streamline refinance program.
The process is streamlined, hence the name, making the process quicker, easier, and requiring less mortgage documentation. Income documentation is usually not even required. In some cases a credit check is not performed. A streamline refinance is like any other refinance however, there will be fees and closing costs associated.
The home affordable refinance program, or HARP. Is a refinance program created by Fannie Mae to help homeowners who are upside down on their mortgage refinance into a lower payment and mortgage rate. In order to qualify for HARP you’ll need a conventional loan owned by Fannie Mae or Freddie Mac.
Adjustable-Rate and Fixed-Rate Mortgages
If you have an adjustable-rate mortgage then refinancing into a fixed-rate mortgage before your rate increases is imperative. There are different fixed-rate terms, 15 year and 30 year fixed-rate mortgages are the most popular.
While a 15 year fixed-rate will come with a higher payment, your interest rate will be lower saving you tens of thousands of dollars in interest.
Refinancing to Drop Mortgage Insurance
If you’re paying PMI (private mortgage insurance) then it’s costing you thousands of dollars a year. If you have a conventional mortgage, PMI will cancel once the loan-to-value ratio of the loan reaches 78%.
FHA loans require MIP (mortgage insurance premium) for most, if not the entire term of the loan, regardless of the LTV ratio. In order to drop mortgage insurance on an FHA loan is to refinance into a conventional loan.
If you’re paying PMI and you have a 78% or lower loan-to-value ratio then refinancing makes sense regardless of the closing costs and fees because you’ll be saving thousands of dollars per year.
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Refinancing Because Your Credit Score has Increased
Your credit score is directly tied to the mortgage rate you receive on any loan. When you get a mortgage your FICO score will gradually increase over time as long as you make your monthly mortgage payments on time.
If your credit rating has improved from when you received your mortgage then refinancing may help lower your mortgage rate and save you money.
If you have bad credit you could still refinance your mortgage and get a lower rate with a streamline refinance. However, in order to get the best rate you will need good credit. Here are some tips to increase your credit score before applying.
Tips to Increase Your Credit Score Before Refinancing Your Home
Pay down your credit card balance
The amount of available credit you have used up on your credit card accounts is called your credit utilization ratio. This ratio makes up 30% of your overall FICO score. Only your payment history has a bigger impact on your credit rating.
If you’re carrying high credit card balances your credit score is suffering. You can increase your score by several points just by paying your credit card balances to below 15% of the credit limit.
Get added as an authorized user
An authorized user is a second person with access to a credit card account. When an authorized user is added the entire account history is added to that persons credit history, helping their score. The great thing is that you don’t even need your own card, this reduces the risk for the account holder.
Don’t apply for any new credit or loans
If you know you’re going to be applying for something big, like refinancing your home. It’s important you keep your credit inquiries and recently opened accounts to a minimum. Have recent hard inquiries on your credit means you may be desperate for money and it will hurt your chances of being approved with the best rates.
The Lenders Network has the largest network of mortgage lenders that specialize in home loans for borrowers with all types of credit scores. We will match you will the best lender based on your specific situation.