What does it mean to refinance your mortgage?
When you refinance your mortgage, you replace the existing mortgage with a new one. This is usually done to reduce the monthly payment, interest rate, or a combination of both.
Perhaps the current mortgage is an adjustable rate mortgage (ARM), which when the loan was taken out, the payments were attractive due to the initial interest rate. Sometimes, an adjustable rate mortgage will have numbers in the terms like 5/25. This indicates the ARM will have a fixed rate for the first five years (possibly lower than normal), followed by an adjustable rate for the remaining 25 years.
At the end of the fixed rate term, the interest rate will adjust based on the bank index plus a margin set out in the terms of the mortgage. This could be higher than anticipated and make the monthly payments out of reach for a homeowner, resulting in the need to refinance.
What are the benefits of refinancing?
There are many advantages to refinancing a mortgage—here are some of them.
Are there risks in refinancing?
One risk that might transpire when refinancing a mortgage can be possible penalties from paying off the existing mortgage balance. Written into the mortgage agreement may be a clause stating what fees or penalties will be incurred if the loan is paid off within a certain time frame, and with some mortgages, these penalties can be thousands of dollars. Before refinancing, it is wise to check if there are any penalties, how much they will be, and if the new refinanced mortgage will cover them.
How do I refinance?
The refinancing process is practically the same as applying for a first mortgage. Homeowners need to get qualified for a refinance loan, in the same way as getting approval for the original mortgage.
Whatever the reason for considering to refinance the loan, checking with the current lender to see what options are available is a good first step. Also, shop around for lenders who have any special offers. Many mortgage companies allow online applications with only basic information submitted by the homeowners to give an initial quote. Ask whether any closing costs can be “rolled into” the new mortgage, so no actual cash is required at closing.
Like the original mortgage application, be prepared to submit all the documentation needed by the lender. Collect wage statements (generally three months’ worth), recent tax returns, bank statements, plus anything else that shows the state of your finances.
Since any lender will look at a potential borrower’s credit report, it might be prudent to take time to look at the report and try to find ways to boost the score. Keep payments up to date, lower credit card balances, but do not close any unused or zero balance cards, because closing an account may have an effect on the credit use ratio.
No matter what the reason is for refinancing a mortgage, make sure your finances are in order and they can substantiate the amount requested, and that the new monthly payment is well within reach.