There are many reasons why homeowners choose to refinance their mortgages. It can help you reach certain financial goals, such as lowering your monthly mortgage payment or locking in a lower interest rate. If you find yourself wondering, “should I refinance my mortgage,” you’ve come to the right place. Here’s an educational guide that will help you decide if refinancing your current mortgage is the right tool for you.
What Is A Mortgage Refinance & How Does It Work?
A mortgage refinance is a financial tool that allows you to take out a new mortgage when you have an existing mortgage. When refinancing your mortgage, you pay off your old mortgage and start over with the terms of your new mortgage. Click here to learn more about how a mortgage works.
The process of refinancing works similarly to when you selected and applied for your first mortgage. You can shop amongst mortgages available to homebuyers and select the best option for your financial goals.
You’ll fill out a mortgage application, provide the required financial documentation, and wait for approval. This time around, however, you won’t have to deal with the stress of buying a house and moving. Instead, you’re merely replacing your existing mortgage with a new one.
It takes an average of 38 to 48 days to refinance a mortgage. However, this wait time can increase when lenders get busy. For instance, when interest rates drop, more homeowners submit applications to refinance, and approval times can take longer.
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Why Should You Refinance Your Mortgage?
Refinancing your mortgage can be advantageous in certain scenarios. For instance, you can take advantage of a market change resulting in lower interest rates. You could also change your loan terms and bring down your monthly payments. Some homeowners refinance because they want to cash out some of their home equity to pay off debt.
The following discusses several common reasons why homeowners choose to refinance their mortgages.
Lower Interest Rates
One of the key reasons a homeowner will refinance their mortgage is to take advantage of a lower interest rate.
The real estate market ebbs and flows, meaning there will be periods when the interest rates are relatively high. Eventually, these rates can drop below what you’re currently paying on your mortgage.
Another reason why you could take advantage of a lower interest rate is that your credit profile substantially improved. Homeowners with higher credit scores can get better interest rates. Let’s say you took out an FHA loan a few years ago when your credit score was 600. Since then, your credit score has increased to 800. There’s a good chance that you can take out a new mortgage with a significantly better interest rate. To sweeten the deal, you could potentially rid yourself of the private mortgage insurance that was originally required of your FHA loan.
Bringing down your interest rate and thus your monthly payments and total cost of financing your home is often a no-brainer.
Changing Your Loan Term
Another reason why homeowners refinance their mortgages is to change their loan terms.
Most home loans come with a 15-year or 30-year term, and this means that you pay off your mortgage at the end of the selected time frame. Your mortgage payment may be lower when you select a longer loan term, but then you end up paying more interest over time.
For example, you might currently have a 30-year mortgage and you choose to refinance using a 15-year mortgage. Perhaps your income has increased, and you can handle a higher monthly payment. You elect to make these higher payments knowing that your loan will be paid off years earlier, and you get to pay less interest over time.
Conversely, you might choose to extend your mortgage to 30 years instead of 15 years. This will lower your monthly mortgage payment and improve your monthly cash flow. Perhaps you also choose to invest your spare cash at a higher interest rate and save more money.
Paying Off Debts
Do you have a large life expense or an overwhelming amount of debt to pay? Although it isn’t always recommended, you have the option of refinancing your home to tap into equity.
If your mortgage is roughly five years old, you’ve likely built up a significant amount of home equity. You could apply for a cash-out refinance that replaces your existing mortgage with a higher-value loan. Your lender will give you the difference between the two loan amounts in cash, which you can then use to pay your bills.
Losing the equity you’ve built up in your investment isn’t ideal. If you’re in a financial pinch, it’s recommended that you explore other options. However, homeowners can tap into their equity as a last resort.
Making Improvements Or Renovations
What’s a good reason to tap into the equity of your home? Financial advisors typically won’t recommend a cash-out refinance for purposes such as paying for your child’s college tuition or paying off your bills. (These are valid reasons, but it’s best to use other options if they’re available.)
However, the story changes completely if you’re putting the cash directly into your home.
Let’s say you’re ready to renovate your home by making repairs and improvements. Mortgage rates typically range between 4 and 7 percent. Credit card rates can vary between 12 and 24 percent, depending on your credit rating. You could put charges on your credit card or take out a personal loan, but you’ll end up paying more in interest. Instead, you could pursue the more affordable option of refinancing your mortgage and reinvest the proceeds into your home.
If you have enough equity in your home, you can complete your projects without paying excessive interest.
Saving For Retirement
When saving up money toward a certain goal, you’ll be most effective when leveraging time and compound interest. Saving for retirement is no different, and because the savings goal is so large, the more years you have to accumulate interest, the better.
If you have equity in your home but haven’t maxed out your annual contribution limit, you may want to consider taking a cash-out refinance. When you get paid the difference between your two mortgages, you can invest it in your retirement fund and potentially make more money over time.
It’s recommended that you consult your financial and retirement advisors before pursuing this option to ensure that the strategy makes sense for your personal circumstances.
Converting An ARM To A Fixed-Rate Mortgage
Some homeowners will refinance their mortgage to lock in a fixed interest rate. An ARM (adjustable-rate mortgage) is a mortgage with an interest rate that adjusts in correlation with the market. New homeowners often opt for an ARM because it can offer a lower-than-average rate for the first few years. However, over time, the interest rate can begin to creep up. Here, there’s an option to refinance to convert the mortgage to a fixed interest rate.
Eliminating FHA Or PMI Loans
Last but not least, you can also refinance your mortgage to rid yourself of mortgage insurance. For instance, FHA loans come with mortgage insurance premiums (MIPs) that can cost you thousands per every $100,000 borrowed every year. Refinancing with a new mortgage that isn’t backed by the FHA is the means to get rid of these premiums.
There are conventional mortgages that also require private mortgage insurance (PMI) payments if you put down less than 20 percent. You could refinance your mortgage to rid yourself of PMI, but that may not be necessary. Find out if you qualify to cancel PMI once you reach 20 percent equity.
30-Year Vs. 15-Year Refinance Mortgage
Are you having trouble deciding between a 30-year vs. 15-year mortgage for your refinance?
Most homebuyers opt for a 30-year mortgage when purchasing their home because it gives them more time to pay it off and thus provides lower monthly payment options. However, these payments mostly go toward interest and prevent you from building home equity in the beginning.
If you wish to build equity faster, you may choose to refinance into a 15-year mortgage. You’ll have a higher monthly payment and thus less cash to spend or invest each month. On the other hand, you’ll lock in a lower interest rate, pay less interest over time, and pay off your mortgage much faster.
For some homeowners, the pressing priority is to obtain a lower monthly payment over building equity. For this reason, they may choose to refinance into a 30-year mortgage (instead of a 15-year mortgage.) Although it isn’t ideal to recommit yourself to another 30 years of repayments, sometimes there are no other options, and you need to keep your home and pay your bills. Not to worry, though! When your finances improve later on, you can pay down your principal by making extra mortgage payments or even refinancing a second time.
How Much Does It Cost To Refinance A Mortgage?
The total cost of refinancing a mortgage varies by lender, your creditworthiness, and the amount you’re refinancing. However, the average cost of refinancing a mortgage is roughly between 2 and 6 percent of the loan amount. These costs typically include fees for the application, origination, appraisal, credit checks, and attorneys.
If you can’t afford to pay closing fees out-of-pocket, look for a lender that offers a no-cost refinance option. Although you can’t get rid of closing costs completely, some lenders allow you to roll your costs into the loan. However, it’s best to pay the costs upfront to avoid adding to your interest payments.
How Soon Can You Refinance A Mortgage?
How quickly you can refinance your mortgage depends on the type of mortgage you currently have, and the type of mortgage you’d like to refinance into. There are also lender-specific requirements to consider as well.
For most conventional loans, lenders require a seasoning period. This is a required amount of time you must wait before you can refinance your mortgage. In some cases, the seasoning period can be short or nonexistent, meaning you can refinance as soon as you’d like.
If you want to pursue a cash-out refinance, however, it makes sense to wait a few years. That’s because you need to build up enough equity to cash out on.
Federal home loan programs require specific seasoning periods. For instance, if you have an FHA or VA loan, then you must wait 210 days after closing before you can refinance.
Pros & Cons of Refinancing Your Mortgage
There is no right or wrong when it comes to refinancing your mortgage. In some cases, refinancing your mortgage can put you in a stronger financial position. In other cases, it may be better to wait.
Here are some advantages and disadvantages to consider if you’re considering refinancing your mortgage:
Refinancing a Mortgage Pros
Option to lower your monthly payment
Option to pay off your mortgage faster
Option to pay less interest over time
Take advantage of a lower interest rate due to market changes or improved credit worthiness
Get rid of mortgage insurance premiums
Tap into your home equity using a cash-out refinance
Refinancing a Mortgage Cons
May increase your mortgage payment and total interest cost
Pay closing costs again
Requires effort to shop for a new mortgage and submit application paperwork
Hard credit checks performed by lenders will impact your credit
Should I refinance my mortgage? After reading this guide, you likely came away with an understanding that there is no straightforward answer to this question. There is a myriad of benefits associated with refinancing a mortgage, while there are also negative consequences.
The key factors to include in your decision include the type of mortgage you currently have, as well as the type of mortgages you could potentially refinance into. In some cases, refinancing is a smart option. Perhaps you can pay off your mortgage earlier or lock in a better interest rate. On the other hand, refinancing could serve as a band-aid for existing financial issues that must be addressed. Regardless of your decision, this dilemma helps to highlight how valuable your home equity truly is.
We strongly suggest consulting a financial advisor to make sure that a mortgage refinance is the best tool to achieve your desired financial outcomes.
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