I frequently see and hear commercials suggesting that I should refinance my home. I also get messages from my mortgage company saying that I should do the same thing. While refinancing has many advantages, it is not always the right move at that moment. Many different factors need to be taken into consideration before making the decision to refinance. Here, I will discuss some tips surrounding the refinancing process.
According to bankrate.com the definition of refinancing is the process by which one loan is replaced by another loan, in most cases with more favorable terms. The new loan is used to pay off the original loan. Refinancing is done to take advantage of lower interest rates, reduce monthly payments, consolidate debt, or free up cash. The main point to understand in the definition is that the current mortgage is going to be swapped out for a new mortgage, which generally helps the buyer meet their objectives. I’ll discuss these objectives below, as there are a few ways that refinancing can benefit the homeowner.
The list below includes the primary objectives when financing. These are potential benefits that can be gained by refinancing your home. Typically, all these benefits are not seen in the same refinance. Most buyers will target one of these objectives when a decision is made to refinance:
Reduction of the monthly payment
Mortgage payments can weigh on any family, especially when times are tough. By lowering the payment amount this makes the mortgage more affordable to the average person. There are typically two ways to lower the payment. First, is by agreeing to a lower interest rate. At times when interest rates are lower, homeowners can take advantage and agree to a new loan locked at a lower rate. This lower rate can make a huge difference in payment amounts, especially if the original loan was executed with a high interest rate. Another way that the monthly payment can be lowered is by extending the duration of the loan. For instance, a homeowner may have 10 years left on their mortgage, by extending the length of time to pay back the owed amount the homeowner now can decrease their monthly payment. This method, unfortunately, is done at the expense of paying more interest over the life of the loan.
Take out equity
What is known as a cash-out refinance, homeowners can cash out the equity in their house (difference between amount owed on the original loan and the amount of the new loan). Cash-out refinancing is typically done at the same time as lowering an interest rate. This is often advantageous when the buyer needs a large sum of money for projects around the house, large scale vacations, or paying off debt.
Pay off loan faster
This option is extremely popular for those who have money available to pay off their house. An example is refinancing the loan from 30 years to 15 years, this option allows the homeowner to pay off their mortgage in half the time. The shortening of the loan drastically decreases the amount of interest that is paid off over the course of the loan. Of course, by shrinking the length of the loan, the homeowner is also driving up their monthly payment. Again, this is a good option for homeowners who can pay off larger monthly amounts and have the objective of owning their home outright.
Eliminate FHA mortgage insurance
FHA (Federal Housing Administration) mortgage insurance premiums cannot be cancelled like private mortgage insurance unless the homeowner sells their house or has enough equity accumulated. By getting out of the original mortgage the FHA mortgage insurance can be avoided.
Move from adjustable-rate loan to fixed-rate loan
Adjustable-rate mortgages can see their interest rates increase, which can cost the homeowner more money than a conventional mortgage over the life of the loan. One reason to refinance is to get out of the adjustable-rate mortgage and into a fixed-rate mortgage. The biggest advantage of a fixed-rate mortgage is the consistent monthly payment amount, which is not necessarily the case with an adjustable-rate mortgage.
Now that most potential reasons to refinance have been laid out it is now time to discuss what happens during a refinance. When the homeowner refinances, their new loan goes to pay off the balance on their original mortgage. Again, leveraging the refinancing process can help with achieving some of the objectives laid out above. When applying to refinance, the buyer still needs to file an application with a lender and get approved for the new loan. This is the same process a person purchasing a mortgage on a new home will have to follow.
When refinancing, it is often tempting to move into another 30-year loan, as this will keep payments low. However, this just means it will take even longer to pay off the whole loan. The homeowner, when refinancing, can ask for the duration of the new mortgage to match the duration of the current mortgage, or less. For instance, if the homeowner has 22 years left on the original mortgage, when refinancing, the homeowner can ask for the term to stay at 22 years. In this case, the primary objective would likely be to lower the interest rate, therefore decreasing how much is owed on the loan.
I suggest that those who are savvy with the computer, or know someone who is, try using a “Mortgage Refinance Calculators” online. These tools allow the homeowner to input the information on their original loan, as well as on their best guess on their new, refinanced loan and determine a “break-even” point that includes the fees that are typically associated with a new mortgage. The mortgage calculator can also be beneficial when comparing more than one refinance option.
I strongly suggest to shop around for the best interest rate among multiple lenders. Homeowners can call individual lenders and see what their mortgage refinance interest rate is. The lender is required to issue an estimate within a few days of receiving the homeowner’s information. The various loan estimates can be compared using the previously mentioned calculator to determine which loan is the best option. Every hundredth of a percent is important when trying to save money over the course of a long-term loan like a mortgage.
Lastly, here is a step-by-step process to refinancing:
- Determine the reason for refinancing. Refinancing is not appropriate for everyone and does require the payment of fees in most cases. The homeowner should have a strong reason to refinance. Typically, reducing the monthly payment, taking out equity, or paying off the loan faster are the most popular reasons.
- Shop around for the best interest rate. Remember, every little bit counts when saving money over the course of a mortgage.
- Send in mortgage applications with multiple lenders. If these are submitted within a two-week period it will lower the impact on the homeowner’s credit score.
- Choose the best lender based on a careful review of the different loan estimates that are provided. This is the point where a decision needs to be made which loan/lender the homeowner goes with.
- Lock in the interest rate. This rate can fluctuate, so when the interest rate is officially locked in, it cannot change. The lender will try to close the loan before the rate expires.
- The final step is closing on the loan. This is when closing costs are paid and the new mortgage and its terms go into place. This is the beginning of realizing the gains that you set out for when starting the refinancing process.
