How does refinancing work?
Refinancing a mortgage means paying off an existing loan and replacing it with a new one.
Refinancing your mortgage can be a great way to reduce your payments, get cash, and pay off your mortgage faster, but it can also be expensive and time-consuming even when it’s done right.
The number 1 tip to ensure that refinancing your mortgage is the best choice is for you to determine the ultimate goal / or purpose for the refinance. Depending on what you want, you might not need to go through the process of refinancing at all.
The best way to figure out your ultimate goal with your mortgage is to take out a sheet of paper and write down what your perfect scenario would be after the refinance is done.
When is it a good idea to refinance your mortgage?
Some good reasons for refinancing your mortgage:
Refinance to change loan providers
Once you decide on a loan provider and get into a mortgage contract with them, the only way to leave is either to pay off the loan, refinance the mortgage, or hope that the mortgage gets bought by a different company to service the loan.
So if you hate your loan provider because they have awful customer service, charge too many fees, or you just don’t want to be associated with them anymore, then refinancing is likely the easiest option.
Refinance for lower interest rates
When interest rates a low, it’s a good time to consider refinancing into a fixed rate to lock in those lower numbers.
The rule of thumb is for you to consider refinancing if your new rate is at least 1 percent lower than your old rate. However, I’ve seen folks save thousands in interest with just a .5% rate difference.
Companies won’t just automatically change the rate, although if you are refinancing with the same company the steps may be a little easier.
Having a lower interest rate can prove to have substantial savings over the course of the loan. A $300k home with a 4.25% interest rate on a 30-year mortgage will cost a total of $504,730.33 with over $219,000 in interest alone
The same $300k home with a 3.75% interest rate (just 1% lower) with a 30-year mortgage will cost $446,521.68. The total paid in interest would be $161,521.68 nearly $60,000 less!
And it’s super easy to find out a rate (without impacting your credit score at all) using Credible. You can have access to compare interest rates from several banks all in just one place so you can ensure you get the best rate and highest savings.
What could you do with that extra $2000 per year?
Refinance from 30 years to 15 years
If your goal is to pay off your mortgage faster then switching from a 30-year mortgage to a 15 or 10-year mortgage can prove beneficial.
But if the only goal is to pay down your loan faster, this could also be achieved by just paying more every month hence lowering the timeframe for the loan.
So refinancing your mortgage could be a good option, but other portions are available as well.
Refinance to escape PMI
PMI or private mortgage insurance is what you pay to the lender to protect them in case you default on the loan. Now don’t assume that because it’s insurance then it’s for you. Nope, this is to protect your Lender’s investments.
And you pay PMI when you purchase a home on a conventional loan and do not have at least 20% downpayment. PMI costs can range from 0.25% to 2% (however it typically run about 0.5 to 1%) of your loan balance per year. And you don’t get these funds back.
Once your balance still owed is 80% or less of the original appraised value of the home, then you can ask the lender to remove the PMI. But some lenders have now implemented rules to make PMI not be removable.
Refinance to get into a fixed interest rate
If you have a variable interest rate, then you are at the mercy of the rate. When they go up, your payments will go up, when they go down your monthly minimum payments will go down.
It works great when rates are low, but they don’t ever stay low forever, so getting refinanced into a fixed rate can help provide stability to your payments and some peace of mind.
Refinance to get cash from home equity
You can refinance your mortgage using a cash-out refinance to tap the equity in your home.
So when you request the new loan, you request for more than the original loan amount up to around 70 or 80% of the new appraised value. The maximum amount you can make the new loan depends on the lender, but you get the idea.
Here are some numbers to help
Current mortgage owed: $250,000
Appraised home value: $350,000
Cash out Refinanced Mortgage amount: $280,000 (80% of $350,000)
Your cash: $30,000 ($280,000 – $250,000)
The original mortgage holder gets paid, you get the extra, and pay the new monthly payment for the refinance loan amount.
Of course, there are other ways to pull equity from your home using a HELOC (Home equity line of credit) or a HEL (home equity loan).
You’ll own the house past the break-even point.
The break-even point on a refinancing occurs
Frequently asked questions:
1. Can I refinance my mortgage with not so great credit
You could refinance when you have less than perfect credit. However, most companies want at least a 720 credit score to secure some of the best rates.
It also depends on the economic environment as well. You can refinance during a recession, but banks are more likely to increase the credit scores required for refinancing, and/or other factors when there are periods of uncertainty.
2. Can you refinance without paying closing costs?
Closing costs include many fees associated with the mortgage creation process – appraisal fees, loan origination fee, title search, title insurance fee, pre-paid taxes, etc.
You can opt for providers that offer loans with low or no closing costs, however, these usually have higher interest rates, or you do cash-out refinance and use some of the extra funds to cover the cost of the closing costs.
You can also keep funds low by negotiating some of the other lender fees.
As stated before, a refinance of your mortgage can be an important step towards lowering your home expense and building wealth But it’s important to be clear on what you’re ultimate goal is, to determine if a mortgage refinance is right for you.