A Guide to Refinancing Your Home Mortgage
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What does ‘refinancing’ a mortgage mean?
When you refinance a mortgage, it is the process in which the original mortgage loan is paid in full with a new mortgage loan. The reason for refinancing can vary upon the borrower’s situation, but often it is to reduce monthly payments through obtaining a new mortgage with a lower interest rate. For example, if your original mortgage was not a fixed rate but an adjustable rate, and now years into making the mortgage payments the interest rate is much higher than a current fixed rate mortgage, refinancing to a fixed rate isn’t a bad idea! Another popular reason to refinance is to consolidate debt. We will explore other reasons to refinance your current loan as we continue this topic below.
There are misconceptions in relation to refinancing a home mortgage, the most common of which is that it must be done with the lender currently holding your mortgage. Many homeowners receive mailings from their lender that refinancing is a good idea, would be best for your situation, or that interest rates are low and now is the time! It’s all advertising. Speaking with a mortgage broker, an independent licensed professional, will help you decide if refinancing is right for you and your needs.
Another common misconception regarding refinancing is how often you should refinance your mortgage. Not every situation is the same. One homeowner’s needs are not the same as another. Refinancing a mortgage can be costly and takes time, typically 45-90 days. With conforming loans backed by Fannie Mae or Freddie Mac, you can realistically refinance as often as you’d like (if you’re not taking cash out) if you’re only changing the interest rate and/or term of the mortgage. What should be taken into consideration is the difference between your current interest rate and today’s market rate, and how many months it would take for that savings in interest rate to cover the cost of the refinance. A general rule of thumb is 2 years, so if it’s longer than 2 years, would saving the costs of the refinance be more beneficial to you financially in the long run? You can begin to understand why it’s important to speak with a licensed professional before making any decisions.
Types of Refinance
Refinancing a mortgage is not cookie cutter. Just like when you got your original mortgage, there are many options available because you’re essentially obtaining a new mortgage and replacing the old one. Some programs are more streamlined than others, depending on your personal objective. Selecting the right refinance product for your goals is key.
- Rate and Term Refinance: This is the most common type, but the reasons for this may vary. If you originally closed on your home loan with a higher interest rate because the market was not as good, or your credit dictated a high rate, and your credit has improved and interest rates have stayed the same or dropped, you would want to consider a refinance for a new interest rate. If you originally closed on your home loan with a 30-year term because the long term made the payment more affordable at your current budget, but in the last 2 years you’ve significantly improved your income, you would want to consider a refinance for a new term/rate with the goal of paying less in interest over the life of the loan.
- Cash Out Refinance: This is the second most common type, but again the reasons for this vary. If you have equity in your home, and you need cash, this is the refinance you would want to consider. The term “cash out” is referring to taking money out of the equity, thus increasing the overall loan amount. This cash to the borrower at closing can be used in a variety of ways, including paying off other high-interest debts or remodeling a home. Whatever you chose to do with the money is your decision, but you must consider that an increase in the total loan amount will increase your monthly mortgage payment. Ideally, you may be able to offset the increase in the monthly payment with a lower interest rate if it’s available and you qualify for it.
- Cash In Refinance: This type of refinance is typically done by a borrower to bring the total loan amount below the loan-to-value (LTV) mortgage insurance threshold. With a conforming loan from Fannie Mae or Freddie Mac, the LTV threshold to avoid the extra payment of mortgage insurance is 20 percent. A borrower may choose to do a cash in refinance if they have the funds to pay down the total loan amount to less than 80 percent LTV. The purpose of this type is to lower the monthly payment by removing the mandatory mortgage insurance, and hopefully the market and your credit score dictate a lower interest rate too!
Should you refinance?
Refinancing a mortgage isn’t always about lowering the payment. There are situations where increasing your payment is financially beneficial too! As we’ve stated before, every scenario is different, but if your circumstances in life have changed significantly from when you first obtained your mortgage, it certainly doesn’t hurt to speak with a licensed mortgage professional, like a mortgage broker.