A mortgage is the biggest expense in most people’s budgets. This monthly expense can stick around for 30 years through ebbs and flows in your income. Some people refinance their mortgages to reduce their monthly payments, while others want to tap into the equity they have accumulated in their homes. This guide will explore how mortgage refinances work, the pros and cons, and how to get started.
What is Mortgage Refinancing?
A mortgage refinance involves swapping your current mortgage with a new one. This new mortgage will have a different rate and terms, which will impact your monthly payment. You can extend the duration of your loan to minimize your monthly payments. Some people also increase their mortgage balances so they can access the differences as cash.
Why Do Homeowners Consider Refinancing?
Homeowners primarily refinance to tap into equity and reduce their monthly payments. However, some homeowners refinance to lock in a favorable interest rate or get out of debt sooner. You can turn a 30-year mortgage into a 15-year mortgage to become debt-free sooner, but that path will increase your monthly payments.
The Concept of Refinance Mortgage
Before you determine if refinancing a mortgage is right for you, it’s important to understand the concept. Here’s what you should know about refinancing a mortgage.
How Does Mortgage Refinancing Work?
A mortgage refinance adjusts your monthly mortgage payments. You’ll also have to pay several fees, such as closing costs, to finalize a refinance. You will need a sufficient credit score and a loan-to-value ratio that is low enough to get approved. Lenders will review your finances and credit to determine if you are eligible for a refinance.
The Different Types of Refinancing
These are some of the mortgage refinances you can use for your property:
- Cash-out refinance: Tap into home equity by replacing your old mortgage with a new one that has a higher balance.
- Rate and term refinance: These loans involve changing the rate and term length of your mortgage.
- Cash-in refinance: You can put additional capital into your mortgage to get out of debt sooner. Cash-in refinances are less common than cash-out refinances, but they can be optimal for people who inherit a windfall of cash.
- Streamline refinances: You can use this type of refinancing for FHA, VA, and USDA loans. This refinancing does not require a home appraisal.
- No-closing-cost refinance: You won’t have to pay closing costs but will end up with higher monthly payments.
- Reverse mortgage: You get to borrow money against your home equity without having to repay the mortgage as long as you fulfill certain conditions. Reverse mortgages are only available for people who are 62 years or older. It’s only available for a primary residence.
Advantages of Refinancing a Mortgage
Refinancing a mortgage can present several benefits for homeowners. These are some of the perks.
Lower Monthly Payments
Adding more years to your mortgage will reduce your monthly payments. This type of rate and term refinance allows you to spread your monthly payments across more intervals. Lowering your monthly payments will free up more space in your budget for other expenses.
Shorten the Term of Your Loan
Some people cut off a few years from their mortgages to get out of debt sooner. While your cost of living will go down substantially once you are done with the mortgage, you will face higher monthly mortgage payments if you shorten the term.
Cash Out Home Equity
You can use home equity for any purchase. Some people use home equity for fun purchases like vacations, while others use them for vital expenses like medical bills. Knowing that you can tap into home equity with a cash-out refinance can provide some ease. You also won’t get stuck with a second mortgage if you opt for a cash-out refinance.
Change Mortgage Companies
If you don’t like your current mortgage company, you don’t have to stick with them. Refinancing your mortgage with a new lender can help you get out of an unfavorable relationship with your current lender.
Disadvantages of Refinancing a Mortgage
All financial products have their downsides. These are some of the disadvantages to keep in mind before getting a refinance.
Fees and Closing Costs
Closing costs can range from 2% to 6% of your new loan’s balance. Cash-out refinances are more expensive than HELOCs and home equity loans since the loan balance is higher. You will also have to contend with other fees along the way.
The Savings May Not Be Worth It
Even if you reduce your monthly payments, the closing costs and other fees can wipe out your profits or make them minuscule. A refinance can make more sense if rates have dropped a bit and you still have a lengthy loan term.
You Could End Up In More Debt
Adding more years to the backend of your mortgage will keep you in debt longer. Mortgage lenders use amortization schedules that front-load the interest payments, so it will take more time before you make meaningful payments toward your principal. Making two monthly mortgage payments instead of one can mitigate amortization and get you out of debt sooner.
May Potentially Reduce Your Equity and Credit Score
A cash-out refinance will give you less equity in your home, which can matter if you need to borrow against your property in the future. A refinance will also trigger a hard credit check, which will hurt your score. It’s also possible to lose points on your credit score if you make late payments. A shorter term can increase the likelihood of falling behind on payments since the monthly payments are higher.
The Process of Refinancing a Mortgage
Refinancing a mortgage involves a few steps. Here’s what the process looks like.
Choosing Your Lender
You can choose from many mortgage lenders, and you don’t have to work with your current provider. In searching for a reputable and reliable mortgage refinance lender, consider one who is well-equipped to address your specific needs and financial goals. In this way, you’re assured of getting the best refinancing options available to you.
Shopping for the Best Refinancing Rates
Compare rates and terms when shopping around and comparing lenders. While you can also look at other perks and features, the rate and terms are the most critical components. They determine how much you pay each month and what you save with one lender compared to another.
Applying for a Mortgage Refinance
Mortgage lenders will provide instructions on how to apply for a refinance. You will have to provide basic information like your ID, proof of address, and Social Security Number. You will also need a sufficient credit score and debt-to-income ratio to receive financing.
Closing On Your New Mortgage
After you get approved, get your property appraised, and complete the process, the last step is to close on your new mortgage. You should review the fine print one more time to ensure the rate and terms align with your expectations.
Factors to Consider Before Refinancing
A refinance is a significant financial decision that requires plenty of thought. These are some of the factors to assess before refinancing your mortgage.
Your Credit Score and Current Financial Situation
A higher credit score will make it easier to get financing and end up with a competitive rate. However, homeowners with fair credit may want to delay their refinancing, as they will receive higher interest rates.
Current Interest Rates
Interest rates remain elevated after several rate hikes from the Federal Reserve. If the Fed decides to lower rates, it can present a good opportunity for people who want to refinance.
The Value of Your House
Homeowners gain equity when they make monthly mortgage payments and when their properties gain value. If you want to borrow money, a cash-out refinance can be a good choice if your property has gained value.
The Remaining Duration of Your Existing Mortgage
A refinance doesn’t make as much sense if you are approaching the finish line. It’s better to stay the course if you have less than five years left than refinance and prolong your debt. However, some people may have to refinance because of their financial situation.
The Timing of the Refinance
A refinance will result in a hard credit check that temporarily hurts your credit score. This hard inquiry will affect your score for a year. While it’s possible to recover quickly and still get financing in other ways, you shouldn’t refinance your mortgage leading up to a significant loan application.
Conclusion: Is It a Good Idea to Refinance Mortgage?
Refinancing can be a good idea for people who want to lower their monthly payments and tap into home equity. These financial products give you plenty of flexibility, but it’s essential to consider the downsides, like closing costs and the possibility of staying in debt longer. Homeowners should assess their financial situation before deciding if a refinance is right for them.
Frequently Asked Questions About Refinance Mortgage
Refinancing will temporarily hurt your credit score due to the hard credit check that’s involved with the process.
You can get the best refinance rates by comparing lenders, building your credit score, and reducing your debt-to-income ratio.
A refinance usually costs anywhere from 2% to 6% of your new mortgage’s balance.
