Refinancing a mortgage can turn into a blessing for borrowers, as it has a plethora of benefits. It can help to get a lower rate, reduce monthly payments, avoid mortgage insurance premiums, or decrease their loan terms.
What is mortgage refinancing?
When you replace your existing home loan with a new one, it is referred to as mortgage refinancing. Like all other loans, a thorough check of your credit, income, employment history, and finances, is involved here. Lenders will get a home appraisal done to find out the present market value of your home and how much equity you have in it.
While refinancing, the borrowed money from the new loan is used to clear the existing loan. There are several reasons for considering refinancing. For instance, some do it to get a lower interest rate and decrease monthly payments, while others do it for shortening the term of their mortgage.
What is a cash-out refinance?
There is an option for cash-out refinance too, which lets you borrow against the equity you have in the property. It extracts a portion of the difference between what you still owe and its current value. Several lenders put a cap on cash-out refinancing, at 80% of the home’s total value on most loans. You could end up with a lower rate in the process. The money you get from the home’s equity can be used for consolidation of debts with higher interest or home improvements.
Why should you consider a mortgage refinance?
Ideally, you need to refinance for saving money on your home mortgage. Take a look:
Getting a lower interest rate
You might consider this option if you wish to stay in your home for a long time and are refinancing at a lower interest rate. When you reduce your mortgage rate, the monthly payments go down as well, provided the repayment term remains unchanged. Mortgage refinancing can work out great, especially for those whose credit score has improved. Make sure you check credit score and history before proceeding further. Remember that a refinance might incur fees from 2% to 5% of the loan balance due. It is advisable to look for refinancing options that help to save money with a lower interest rate, while keeping the loan term same.
Change to fixed rate mortgage from an adjustable rate
Adjustable rate mortgage involves an initial period of steady interest rate, followed by a floating rate till the rest of the loan is paid off. If you wish to live in a home for just a few years, it is a wise choice to opt for adjustable rate mortgage. You can save quite a bit with a lower rate in the interim.
But if you change your mind and decide to stay in your home on a long-term basis, it might make more sense to convert to a fixed mortgage. For example, if you have a 5/1 adjustable rate mortgage, you can complete a refinance by the time the fifth year ends. Then you could lock in a steady rate over a 30-year fixed rate mortgage.
Steer clear of private mortgage insurance
The standard down payment while purchasing homes is 20%. If you are unable to pay the amount, it is typically required to pay private mortgage insurance (PMI). This is for the protection of the lender, if you default on the loan. Annual PMI premiums can range between 0.5% and 1.5% of the mortgage. If the balance on the mortgage goes below 80% of the value of the home, you can cancel the PMI. But keep in mind that Federal Housing Administration loans are accompanied by mortgage insurance for the entirety of the loan term.
Remove borrower from mortgage
If you are getting divorced and wish to remove your former spouse’s name off the loan, then refinancing is a great idea. This condition is also applicable if you purchased the property with a friend or relative. The person who is opting for refinancing the loan into their name has to qualify for the new loan, solely with their own income, credit and employment.
How much does it cost to refinance a mortgage?
Refinancing does help save money in the long run, but you have to factor in upfront fees. Here goes:
- Fees charged by the lender such as a mortgage application fee, loan origination charges, and points.
- Title search or insurance fees.
- Third-party fees, such as the appraisal fee, document recording and a credit check.
- Escrow costs that include homeowner’s insurance and property taxes.
Closing costs can vary depending upon the new loan amount, credit score, debt-to-income ratio, loan program and interest rate.
What is the break-even point on a mortgage refinance?
One of the most important factors when deciding if you should refinance a mortgage is when you will break even on the costs. This break-even point is calculated by adding all refinancing closing costs and then finding out the number of years it will take to make up for those expenses, using savings from your new mortgage payment compared to your previous one. The break-even period is listed in the form of the number of years for which you have to make new monthly payments, before recouping costs of refinancing.
Always think about how long you wish to stay in your home. If you plan to move elsewhere in a few years, it doesn’t make much sense from a financial point of view, even if the interest rate is low. You might not get enough time to break even on closing costs. Ideally, you should be in your house at least 2-5 years after refinancing.
If you have worked out the numbers and decided to go ahead with refinancing, start looking for a suitable lender. Ensure that everything is documented in writing such as interest rates and fees. Lenders usually send loan estimates that show a detailed break down of the new loan and all associated fees. These estimates give you a clear insight if the particular lender will work for you or not.