If you have a mortgage loan, you’ve probably thought about refinancing from time to time.
Refinancing into a loan with a lower interest rate seems appealing, but there are costs involved. Frankly, some people (me included) don’t want to go through the trouble of refinancing unless the benefits are significant.
In this article, we’re going to dive into mortgage refinancing so you can know when you should refinance.
Refinance Rates (November 2020)
30-year fixed-rate mortgage
15-year fixed-rate mortgage
5/1 adjustable-rate mortgage
What is Refinancing?
Refinancing is when you take your current mortgage and get another loan to replace it. People refinance their mortgage to obtain a lower interest rate or monthly payment, get shorter or longer-term, among many other reasons.
For example: Let’s say you have a mortgage loan with a $200,000 balance. You speak to a lender and find out you can get a lower interest rate by refinancing your home loan. You will apply for the new loan, and if approved, it will pay off the old loan. You’re left with a new mortgage with the same $200,000 balance with the lower rate.
Minimum Requirements by Refinance Loan Type
Max DTI Ratio
No income limits
No credit Req.
No down payment
No income limits
No down payment
115% of area median income
Home Equity Loan
80% of area median income
When Should You Refinance Your Home Loan?
There are many different reasons people choose to refinance their mortgage. If your interest rate is over 6%, then you should look into refinancing into a loan with a lower mortgage rate.
If you have an adjustable-rate mortgage and the initial rate is set to adjust upward soon, then you can refinance into a fixed-rate.
Top Reasons to Refinance a Home Loan
- Get a lower interest rate
- Refinancing out of an ARM into a fixed-rate
- Change the mortgage term (30-year into a 15-year)
- Lower monthly mortgage payment
- Make home improvements or repairs.
- Remove mortgage insurance
1. To 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 Mortgage 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 initially.
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 look into refinancing your mortgage into a fixed-rate.
4. Pay Off Your Mortgage Faster
If you want to pay off your loan faster, you could pay a little more each month to go towards the principal. However, a ten 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. Get Rid of Mortgage Insurance
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%. FHA loans require MIP for the life of the loan if you put less than 10% down.
6. Use Your Home’s 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 mortgage term.
Home Equity Loan – A home equity loan also uses your home’s 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.
Reserve Mortgage – A Home Equity Conversion Mortgage (HECM) is a type of reverse mortgage that allows you to turn your home equity into a stream of income.
How to Refinance
Refinancing a loan requires as much time and paperwork as getting a new mortgage on a home.
Pinpoint what You Want to Accomplish. People have different goals when it comes to refinancing their home loans. Are you looking to use your equity to get cash, lower your rate, or get a lower monthly payment?
1. Check Your Credit
Your credit rating will determine the interest rate you get when refinancing. The higher your score, the better rate you will get. You can get your free report for free once per year at www.annualcreditreport.com.
If you have any errors on your report, you should dispute them with the three major credit bureaus.
2. Pay Down Credit Card Debt
The balance on your credit cards compared to the credit limit is your credit utilization ratio. Your credit utilization ratio accounts for 30% of your overall FICO score. Pay down your card balances to less than 20% of their limit to maximize your credit rating before applying.
3. Compare Loan Offers from Multiple Lenders
Some homeowners make the mistake of refinancing with their current lender or the first lender they speak to. This is a mistake because interest rates and lender fees will vary from lender to lender. Get a loan estimate from 3-4 lenders can help you negotiate the best deal with the lender you feel the most comfortable with.
4. Get Your Documents in Order
Refinancing your loan is not usually a quick and easy process unless you do an FHA streamline refinance. You should gather your tax returns, w2’s, paycheck stubs, bank statements, etc. this will help speed up the process.
5. Identify the Benefits
Refinancing is not free; closing costs on a refinance loan can be just as high as when you get a mortgage. And it may be the case that refinancing will not provide as much of a benefit as you had hoped. If that is the case, it’s better to hold off and wait for a better time. Maybe improving your credit score can help get you a lower rate, or you can wait for mortgage rates to drop.
Types of Refinance Loans
- Rate and Term Refinance – This is a traditional refinance that will lower the interest rate and reset the loan term.
- Cash-Out – When a borrower has equity, they can refinance their home for 80% of the property value and keep the difference in cash
- Home Equity and HELOC – A second mortgage on the home using the equity in the house as collateral for a new loan
- FHA Streamline – A quicker loan requiring less paperwork, allowing borrowers to get better terms on an FHA loan
Refinancing with Poor Credit
Having poor credit is does not necessarily mean you can’t refinance your home loan. There are some programs and mortgage companies that can refinance your mortgage with bad credit.
Here are some typical minimum credit score requirements by refinancing type.
- FHA Streamline Refinance – 620 credit score
- Traditional Refinance – 620 credit score
- Home Equity Loan and HELOC – 680 credit score
- Cash-out Refinance – 640 credit score
- 203k Refinance – 660 credit score
How soon can you refinance a home loan?
You can refinance your loan immediately; however, your current lender will not likely allow you to refinance before the loan is 180 days old. You would have to refinance with a new lender.
How much does it cost to refinance?
A refinance loan will have closing costs just like any other home loan. Origination fees and a home appraisal will be charged; on average, you will pay between 2%-4% when refinancing your mortgage.
How long does it take to refinance?
According to Fannie Mae’s report in 2019, the average time it took to complete a refinance was 46 days.
Refinancing your mortgage loan can potentially save you thousands of dollars over the life of the loan, but it’s not always a great idea.
There are costs involved in refinancing, like closing costs and loan origination fees. You need to make sure you have a net positive benefit before deciding to refinance.
Work on improving your credit score before applying, and be sure to shop rates with multiple mortgage companies.
Are you ready to refinance your home loan?