Refinancing a mortgage allows you to tap into the equity in the house, benefit from lower rates, shorten your loan term, or remove private mortgage insurance(PMI). Before you refinance a mortgage, the lender might require a 10 to 20% equity in the property. Most loans also require that you live in the property for at least 12 months before qualifying to refinance. How do you refinance a mortgage, and what do you need to qualify for a mortgage refinance?
In this article, I will explain the mortgage refinance process and offer tips on making the most of it.
What is a mortgage refinance?
Mortgage refinance is when you replace an existing mortgage with a new one, usually at a lower interest rate and favorable terms. Consumers who refinance their homes are usually interested in lowering their mortgage rates, trapping into their equity, and lowering their monthly payments by shortening their loan terms or getting rid of private mortgage insurance.
You can refinance a mortgage at your local bank, credit union, or other lending firm, such as an online mortgage or loan company. Since refinancing a mortgage means you apply for a new loan, having a high credit score, proof of income, and a lower DTI ratio can quickly help you qualify for a mortgage refinance.
What are the benefits of mortgage refinancing?
Mortgage refinancing is one of the most important tactics homeowners use to save money and pay off their mortgages fast. The following are some of the benefits of mortgage refinancing.
Mortgage refinancing lowers interest rates
Homeowners get a chance to lower their interest rates through mortgage refinancing. Suppose you bought a house with an interest rate of 5%. If market rates drop after purchasing the house, you can refinance the house mortgage and get a much lower rate.
Refinance can lower your monthly mortgage payments
Mortgage monthly payments cover the principal, interest, insurance, and property tax. If you have a fixed-rate mortgage, your monthly payments will remain the same for the loan terms. By refinancing your home at a lower rate, however, you will have your monthly payments, which can help you pay off the house faster and save you money for the duration of the loan.
Mortgage refinancing can help you reduce the length of the mortgage
Most conventional mortgages come in 15-year, 20-year, or 30-year fixed rates. For example, you can apply for a shorter term when you refinance your mortgage if you have signed up for a 30-year fixed-rate mortgage. Having a short-term mortgage will reduce the interest you will pay over time. Thus saving you money.
Refinancing a mortgage can help you eliminate mortgage insurance
Private Mortgage Insurance(PMI) is required when you take out a conventional mortgage without having a 20% down payment. Some lenders waive the PMI for first-home buyers with excellent credit profiles. This insurance protects the lender in case the borrower defaults on the mortgage. Borrowers can get rid of this insurance through mortgage refinancing.
You can get equity from the house through refinancing
You can apply for a cash-out refinance if you have built enough home equity. This refinance will get you a new mortgage and leave some of the equity in your pockets. You can then use this equity to cover your projects, such as school fees, home renovation, or a down payment, especially if you want to invest in real estate with BRRRR.
You can pay off the mortgage fast when you refinance
If you qualify for a lower interest rate on the new mortgage, you can use the money you are saving toward the house payments. This will increase your monthly payments, allowing you to pay off the house faster.
You can change the type of interest you have when you refinance
Most home buyers qualify for fixed-rate mortgages. This means that the interest rate will not change for the lifetime of the mortgage. If interest increases or decreases over time, yours will not change. However, if rates decrease over time, you risk paying a higher interest rate on your mortgage when overall market rates are lower. By refinancing your mortgage, you can qualify for an adjustable-rate mortgage. An adjustable-rate mortgage will allow you to lower your interest rate when market rates decrease. This will save you a lot of money.
Refinancing your mortgage will put less stress on your finances
If you can no longer afford your payments due to a salary reduction, you can refinance the house and get affordable rates based on your new salary. It is also possible that your current lender will allow you to make lower payments until you get your financial situation straight.
What are the disadvantages of mortgage refinancing?
Although mortgage refinancing has many benefits, it comes with a cost. Consumers do not just walk into their lenders’ offices and have their houses refinanced for free.
The following are some of the setbacks associated with mortgage refinancing.
- Closing costs. Like any other mortgage, you must apply for a new one and pay closing costs. According to NerdWallet, the closing rate ranges between 2% and 5% of the total mortgage value, which could be a lot for those trying to save money.
- You could encounter a mortgage prepayment penalty. Some lenders have a prepayment penalty and a fee borrowers pay when they pay a partial or all remaining balance above the acceptable limit in a given time. When you refinance a house, your original lender will be paid in full, and the loan will be transferred to another mortgage lender. The original lender will not collect interest they could have collected if the loan had not ended pre-maturity. For this reason, you will pay a penalty for paying your entire mortgage balance early.
- The house could cost you more money in the long term: Refinancing a mortgage could lower your monthly payments and reduce your interest rate. However, this does not necessarily mean you will save money on the house long-term. For example, if you had a 30-year fixed-rate mortgage that you have been paying for like 13 years, it would be a bad idea to refinance it to another 30-year fixed-rate mortgage. This could stretch the time you keep the mortgage. In our example, you will end up paying interest for over 43 years, which could be a lot of money.
When should you refinance a home mortgage?
Refinancing a mortgage is a good idea if it works in your favor.
How do you know if you are ready to refinance your mortgage?
- Interest rates went down: The first reason you could refinance your mortgage is when the interest rate went much lower after getting the mortgage. By refinancing your mortgage, you can benefit from lower interest rates. As a result, you will have fewer monthly payments and save money on the house in the long term.
- You improved your credit score: If you bought a house with a bad credit score, you probably qualified for a higher interest rate. What if, after a few years, you improved your credit score from bad to excellent and paid off other debts holding you back? With these new improvements, you can refinance your mortgage and be approved for a much lower rate.
- You want to use the equity in your house to finance your projects: If you have built enough equity in the house, you can get some of that equity through a cash-out refinance. This will allow you to finance your projects without getting a second loan.
How to refinance a mortgage?
Refinancing your mortgage is a journey that must be approached very carefully. The following steps can help you get ready for your mortgage refinancing process.
1. Decide why you need to refinance the mortgage
What is the main reason you don’t want to stay with your current mortgage lender? Maybe the interest rates went lower, and now you need to benefit. Or perhaps you want to use the equity in your house for other purposes.
Knowing the answer to this question will help you determine how to approach the refinance process.
2. Check your credit score
Your credit score and credit history are critical regarding mortgages. A good credit score will help you secure a low mortgage rate. At the same time, your other debts will determine whether you get approved and the rate you will be approved for. Your debt-to-income (DTI) ratio is important when applying for mortgages.
If your credit score is not good enough, consider improving it before refinancing your mortgage. The following tips can help you improve your score
3. Know how much equity you have in the house
The equity in your house is very important as it will tell you how much money you need to borrow and whether you qualify for a mortgage refinance.
How will you know the equity in your house?
The equity in your house is the difference between its market value and the remaining mortgage balance. For example, if your house is worth $200,000 and you have a $75,000 remaining mortgage balance, your home equity will be $125,000.
As noted by TransUnion, you should have at least 20% equity in your house to qualify for mortgage refinancing. In our example, you have 62.5% equity in the house ($125,000 is 62.5% of $200,000). For this reason, you meet the equity requirements.
You might also like how to get an 800 credit score.
4. Shop around for mortgage lenders
You will need to shop around and compare multiple quotes to get a good rate. The more quotes you get, the better your chances of securing a low rate with better terms.
5. Prepare all your documents
You will need a ton of documents for the mortgage applications. Preparing these documents ahead of time will make your process much easier and faster.
6. Get an appraisal
The lender will need to know the official value of the house before you get approved for the mortgage. This is usually done through the appraisal process, costing about $400 on average. The appraisal cost will be added to your mortgage closing costs.
7. Prepare your closing costs
Like any other mortgage, you will pay closing costs when refinancing. You must prepare this amount ahead of time. Some lenders charge a prepayment penalty. If your current lender has this fee, add it to your budget. Typically, closing costs are 3-5% of your loan balance.
8. Finalize the new mortgage
After getting approved for the new mortgage and putting together everything required, you will sign all necessary documents and pay closing costs. This will lock you into a new mortgage with new terms.
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