Homeowners have more options than tenants. They get to build equity with every purchase and can someday pay off their entire mortgage. However, some homeowners refinance their loans before fully paying them off.
Refinancing can be a convenient way to achieve multiple objectives, such as reducing your monthly payments or getting out of debt sooner. Some refinances even achieve multiple objectives simultaneously. However, you can choose from many types of mortgage refinance loans. This guide will highlight the options and help you decide which one is right for you.
What is a Home Mortgage Refinance Loan?
A home mortgage refinance loan allows you to swap your current mortgage with a new one. Refinancing allows homeowners to get new rates and terms for their mortgages. You can also use a refinance loan to tap into some of the equity you have accrued for your property.
When Should You Refinance Your Home Loan?
Refinancing your home loan usually makes sense if you can secure a lower interest rate. However, it may also be beneficial if you need extra cash from your home equity or want to reduce your monthly payments. Regardless of the purpose, it’s a good idea to refinance your home loan several months after taking out another loan. A recent hard credit check can make it more difficult to get a refinance if your credit score is on the edge of approval. You shouldn’t apply for any other loans or lines of credit (including credit cards) leading up to a refinance.
What are the Benefits of Refinancing a Home Mortgage?
Refinancing a home mortgage can result in some of the following benefits:
- Lower interest rate
- Tap into home equity
- Reduce your monthly payments by extending the loan’s duration
- Get out of debt sooner by shortening your loan
While it’s possible to achieve multiple objectives with the same refinance loan, some of them are contradictory. For instance, you won’t tap into home equity and get out of debt sooner by shortening your loan. You can have one or the other. However, it is possible to end up with a lower interest rate while tapping into home equity. That outcome is feasible if your credit score has significantly improved and rates have dropped considerably since you got your current mortgage.
What is the Downside to Refinancing Your Mortgage?
Refinancing your mortgage has several advantages, but it also has some downsides if you aren’t careful. These are some of the problems that can emerge if you refinance your mortgage
- Higher interest rate if rates have increased since you got your current mortgage
- Higher debt balance between a cash-out refinance and closing costs
- Prepayment penalties from your current lender
- Stay in debt longer and end up with more interest payments
Types of Home Mortgage Refinance Loans
Homeowners can choose from several types of home mortgage refinance loans. These are some of the highlights.
Cash-out Refinance
A cash-out refinance allows you to access some of the home equity you have accumulated over the years. Home equity grows as you make mortgage payments and when your property appreciates. A cash-out refinance increases results in a new mortgage with a higher balance, but you receive the difference between the two loan balances as cash. You do not have to pay taxes on the extra funds you receive from a cash-out refinance.
Rate-and-term Refinance
A rate-and-term refinance involves changing the rate and term of your mortgage. You use the new mortgage to pay off the old one, and you will end up with a new rate and term.
Streamline Refinance
Streamline refinance loans are exclusive for homeowners with FHA-insured mortgages. It’s quicker to get a refinance with this product since there isn’t as much time involved with the underwriting process.
No-closing-cost Refinance
These refinance loans do not require you to pay upfront closing costs. Instead, you can tack those costs to the back of your loan or end up with a higher interest rate. These measures compensate for borrowers who do not want to pay closing costs when they get a new mortgage.
Short Refinance
A short refinance occurs when a lender lets you refinance a mortgage for less than the current mortgage. For instance, a borrower with a $500,000 mortgage may get a short refinance with a $450,000 balance. However, this product isn’t available for everyone. Mortgage lenders only consider a short refinance if a borrower is on the brink of foreclosure. It’s sometimes more cost-effective for a lender to initiate a short refinance than to lose the entire loan.
Reverse Mortgage
Reverse mortgages allow you to tap into your home equity and give yourself monthly payments. It’s similar to how you pay mortgages to the bank, but this time, you receive the payments. Reverse mortgages are exclusively for people who are 62 years or older. It allows retirees to stay in their homes and cover living expenses. They also don’t have to make additional payments for their home while receiving reverse mortgages.
However, it’s possible for your home equity to run out. Then, you’ll be in a tight spot, especially since you’ll be older by the time that happens. Homeowners must keep the property in good condition and pay property taxes to maintain the reverse mortgage. You can only take out a reverse mortgage for your primary residence. Investment properties and secondary homes do not qualify.
Debt Consolidation Refinance
A debt consolidation refinance is just like a cash-out refinance. You have to tap into some of your home equity. However, you aren’t using the extra cash for any ordinary expense. These funds go directly toward other debt that has higher interest rates.
You can use a debt consolidation refinance loan to pay off credit card debt. In most cases, your credit card will have a higher interest rate than what you would get from a refinance. Furthermore, the interest difference between your current and new mortgage won’t be as big of a jump as your credit card’s APR. You can pay off many financial obligations with a debt consolidation refinance and centralize your debt into one account.
How Does the Refinancing Process Work?
The refinance process involves shopping around for lenders and comparing rates and terms. While your current lender may be willing to help with a refinance, other loan providers may have better offers. Applying for many loans will give you more options, but you will have to provide some documents during the application process.
Lenders list document requirements during the application process. You can expect to provide your ID, proof of income, proof of insurance, and proof of residence. After agreeing to a new loan, you will have to pay closing costs. Some lenders let you include these closing costs at the back of your refinance loan. You will also have to pay your current lender any prepayment penalties for paying off your current mortgage early.
How Do You Qualify to Refinance Your Home?
Lenders will consider several factors when assessing your application, but few metrics carry the same weight as your credit score and your debt-to-income ratio. You will typically need a 620 FICO score or higher to get approved. On the other hand, your DTI ratio cannot exceed 50%, and some lenders have stricter requirements.
What Factors Should You Consider for Home Mortgage Refinance Loans?
Homeowners should consider several factors before getting a refinance. These are the highlights.
Current Mortgage Interest Rates
You will receive a new rate if you refinance your mortgage. It doesn’t make as much sense to refinance if you will end up with a higher mortgage rate.
Break-Even Point
Refinances cost thousands of dollars in closing costs, and they’re more expensive if you have a higher balance. However, there is a point when you can potentially break even on your mortgage. It’s possible to break even or even make a profit if you have a lengthy loan term and receive a significantly lower interest rate. Knowing how many years it will take to reach break-even can help you decide if a refinance is worth it.
Credit Score Requirements
You’ll need a 620 FICO score or higher for most conventional refinance loans. Homeowners with FHA loans can get a refinance with a 580 credit score. It’s even possible to refinance your FHA loan through an FHA streamline refinance if your score is below 580. However, you will need a 700 credit score or higher to refinance a jumbo loan.
Home Equity Considerations
You should check how much home equity you have before applying for a refinance. It’s essential to check if a cash-out refinance can fulfill your requirements. A refinance may also not be worth it if you already have substantial equity in your home and are a few years away from a debt-free home.
Loan-to-Value Ratio
The LTV ratio measures the percentage of your debt relative to your home’s value. For instance, a homeowner with a $400,000 mortgage on a $1 million home has a 40% LTV ratio. Many mortgage lenders will not let you exceed an 80% LTV ratio for your property, but some lenders offer more flexibility.
Determining Which Home Mortgage Refinance Loan is Right for You
Homeowners can choose from numerous mortgage refinance loan options. Before you decide on the right refinance loan for you, it’s important to assess your financial goals and what you want to accomplish with a refinance. If you are using a refinance to free up space in your budget, you may want to review your monthly expenses and look for additional ways to save money. A cash-out refinance can be a great resource for short-term needs, but homeowners should also consider the long-term implications of these financial products.
A refinance is a significant decision that will impact your finances. Mapping out how a refinance will change your financial situation and knowing what you want to accomplish after receiving a refinance can lead to a better outcome.
