What is a mortgage refinance?
Mortgage refinancing is a process of replacing an existing mortgage with a new one. Borrowers who refinance their homes are usually interested in lowering their mortgage rates, pull equity out of their homes, lower their monthly payments, etc.
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 mortgage rate: Homeowners get a chance to lower their interest rates through mortgage refinancing. Let’s assume that you bought a house with an interest rate of 5%. If the interest rates went lower after buying the house, you can refinance the house mortgage and get a much lower rate.
- Lower your monthly mortgage payments: After getting a mortgage, you will schedule monthly payments that will cover the mortgage and interest over the lifetime of the mortgage. If you reduce the interest through mortgage refinancing, your monthly payments will go lower.
- Mortgage refinancing can help you reduce the length of the mortgage: You can apply for a shorter-term mortgage when you refinance your 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 get rid of mortgage insurance: Mortgage insurance is required for borrowers who do not have at least a 20% down payment. 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: If you have built enough equity in the house, you can apply for a cash-out refinance. This type of mortgage 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, renovations, etc.
>>MORE: Cash-Out Refinance: Basics And Definition?
- You can pay off the mortgage faster: 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. As a result, you will finish paying off the mortgage faster.
- Change the type of interest rates: 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 increase over time, yours will not change. However, if rates decrease over time, you will risk paying a higher interest rate on your mortgage. So, you can qualify for an adjustable-rate mortgage by refinancing your mortgage. An adjustable-rate mortgage will give you a chance to lower your interest rate when market rates decrease. This will save you a lot of money.
>>MORE: Adjustable-Rate Mortgage (ARM)
- 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 situations straight.
What are the disadvantages of mortgage refinancing?
Although mortgage refinancing has a lot of 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: Just like any other mortgages, you will need to apply for a new mortgage and pay mortgage closing costs. According to NerdWallet, the mortgage closing rates range is between 2% to 5% of the total mortgage value. This amount could be a lot for those who are trying to save money.
- You could encounter a mortgage prepayment penalty: Some lenders have a prepayment penalty which is 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 move to another mortgage lender. The original lender will not collect interest they could have collected if the loan was not ended pre-maturity. For this reason, you will pay a penalty for paying all 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 that you will save money on the house in the 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 turn into a lot of money.
When should you refinance a home mortgage?
Refinancing a mortgage is a good idea only 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 will be able to 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 got 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 that were holding you back? With these new improvements, you can refinance your mortgage and be approved for a much lower rate.
>>MORE: How Does A Credit Score Affect A Mortgage 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 give you a chance 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 from it. Or maybe you want to use the equity in your house for other purposes.
Knowing the answer to this question will help you figure out how to approach the refinance process.
2. Check your credit score
Your credit score and credit history are very important when it comes to mortgages. A good credit score will help you secure a low mortgage rate. At the same time, other debts you have will determine whether you get approved and the rate you will be approved for. This is why your debt to income(DTI) ratio plays an important role when you are applying for mortgages.
If your credit score is not good enough, consider improving it before you refinance your mortgage. The following tips can help you improve your score.
>>MORE: 8 Tips You Can Use To Improve Your Credit Score
>>MORE: What Is A Good Credit Score To Buy A House?
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 your qualification for mortgage refinance.
How will you know the equity in your house?
The equity in your house will be the difference between the market value of the house and the remaining mortgage balance. For example, if your house is worth $200,000 and you have a $75,000 remaining mortgage balance, your equity in the house will be $125,000.
As noted by TransUnion, you should have at least 20% equity in your house in order 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.
4. Shop around for mortgage lenders
To get a good rate, you will need to shop around and compare multiple quotes. The more quotes you get the higher the chances you will secure 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. An appraisal will be conducted and the cost will be added to your mortgage closing costs.
Related articles
Fair Market Value(FMV)
Intrinsic Value: What Is The Intrinsic Value?
Property Tax Assessment & Assessed Value
7. Prepare your closing costs
Like any other mortgage, you will pay closing costs when you refinance your mortgage. You must prepare this amount ahead of time. Some lenders charge a prepayment penalty. If your current lender has this fee, you must add it to your budget.
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.
More learning resources
- Par Rate: Get The Lowest Mortgage Rate
- Mortgage Lender: What Is A Mortgage Lender?
- Mortgage Insurance: Basics And Definition
- Conventional Mortgage Definition
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