What is Refinancing?
Refinancing is when you take your current mortgage and get another loan to replace it. People refinance their mortgage to get a lower interest rate or monthly payment, get a shorter or longer term, among many other reasons.
For example: Let’s say you have a mortgage loan with a $200,000 balance. You speak to a lender and find out you can get a lower interest rate by refinancing your home loan. You will apply for the new loan, and if approved it will pay off the old loan. You’re left with a new mortgage with the same $200,000 balance with the lower rate.
When Should You Refinance Your Home Loan?
There are many different reasons people choose to refinance their mortgage. If your interest rate is over 6% then you should look into refinancing into a loan with a lower mortgage rate.
If you have an adjustable-rate mortgage and the initial rate is set to adjust upward soon, then you can refinance into a fixed-rate.
Top Reasons to Refinance a Home Loan
- Get a lower interest rate
- Refinancing out of an ARM into a fixed-rate
- Change the mortgage term (30-year into a 15-year)
- Lower monthly mortgage payment
- Make home improvements or repairs
- Remove mortgage insurance
1. Lower Your Interest Rate
One of the most common reasons homebuyers decide to refinance their loan is to get a lower interest rate. With interest rates on the rise this year, take advantage by refinancing sooner than later better.
2. Get a Lower Monthly Payment
When you refinance you are getting a new loan and that means a new loan term. If you get a 30 year mortgage, you are resetting the clock and only financing your current balance which is lower than it was originally.
For example: Let’s say you bought your house 10 years ago for $200,000. You used a 20% down payment on a 30 year fixed rate mortgage with a 6% interest rate your payment would be $1,242.61.
Your original balance was $160,000, after 10 years the current balance would be $133,000.
If you refinance to a 4.5% interest rate and a 30 year mortgage your new payment would be $957.22.
3. Refinance out of an Adjustable Rate Loan
If you have an adjustable rate mortgage (ARM) and your interest rate is set to adjust soon then you should look into refinancing your mortgage into a fixed-rate.
4. Pay Off Your Mortgage Faster
If you want to pay off your loan faster, you could just pay a little more each month that will go towards the principal. However, a 10 or 15 year loan will have a lower interest rate than a 30 year mortgage.
In some cases the rate can be as much as 1% lower, saving you a lot of money and helping you pay off your home even sooner.
5. Remove PMI from an FHA Mortgage
All mortgage require private mortgage insurance if you’re loan-to-value ratio is over 80%. For conventional mortgages PMI will automatically drop off after the loan-to-value ratio drops to 78%.
New FHA rules now require borrowers who put less than 10% down to carry PMI for the life of their FHA loan.
The only way these homeowners can remove PMI is by refinancing out of an FHA loan into a conventional loan.
Once your loan-to-value ratio drops to 78% you should contact a lender about refinancing to drop PMI.
6. Renovate or Repair Your Home
If you’ve had your mortgage for a while then there’s a good chance you have built some equity in your home. You can get a new loan by tapping into your home equity as collateral.
Cash-out Refinance – A cash out refinance replaces your existing mortgage with a new loan that includes your loan balance plus up to 80% of the LTV ratio. The cash you borrow is included with the mortgage balance allowing you to repay the loan over the term of the mortgage.
Home Equity Loan – A home equity loan also uses your homes equity as collateral but it does not replace your current mortgage. With a home equity loan you’re getting a second mortgage with a separate rate and payment. You can also get a home equity line of credit, or HELOC loan that works similarly to a credit card.
How to Refinance
Refinancing a loan typically requires as much time and paperwork as getting a new mortgage on a home.
Pinpoint what You Want to Accomplish
People have different goals when it comes to refinancing their home loan. Are you looking to use your equity to get cash, lower your rate, or just get a lower monthly payment.
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1. Check Your Credit
Your credit rating will determine the interest rate you get when refinancing. The higher your score, the better rate you will get. You can get your free report and scores from several different websites.
- Credit Karma
- Credit Sesame
- WalletHub
If you have any errors on your report you should dispute them with the three major credit bureaus.
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2. Pay Down Credit Card Debt before Applying
The balance on your credit cards compared to the credit limit is called credit utilization. Your credit utilization ratio accounts for 30% of your overall FICO score. Pay down your card balances to less than 20% of their limit to maximize your credit rating prior to applying. More tips to improve your credit before applying
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3. Get Your Documents in Order
Refinancing your loan is not usually a quick and easy process, unless you are doing an FHA streamline refinance. You should gather your tax returns, w2’s, paycheck stubs, bank statements, etc. this will help speed up the process.
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4. Identify the Benefits
Refinancing is not free, closing costs on a refinance loan can be just as high as when you get a mortgage. And it may be the case that refinancing will not provide as much of a benefit as you had hoped. If that is the case, it’s better to hold off and wait for a better time. Maybe improving your credit score can help get you a lower rate, or you can wait for mortgage rates to drop.
Types of Refinance Loans
Rate and Term Refinance – Is a traditional refinance that will lower the interest rate and reset the loan term.
Cash-Out – When a borrower has equity they can refinance their home for 80% of the property value and keep the difference in cash
Home Equity and HELOC – A second mortgage on the home using the equity in the home as collateral for a new loan
FHA Streamline – A quicker loan requiring less paperwork allowing borrowers to get better terms on an FHA loan
Refinancing Your mortgage with Bad Credit
Having poor credit is does not necessarily mean you can’t refinance your home loan. There are some programs and mortgage companies that can refinance your mortgage with bad credit.
Here are some typical minimum credit score requirements by refinance type.
- FHA Streamline Refinance – 620 credit score
- Traditional Refinance – 620 credit score
- Home Equity Loan and HELOC – 680 credit score
- Cash-out Refinance – 640 credit score
- 203k Refinance – 660 credit score
Refinance FAQ’s
How soon can you refinance a home loan?
You can refinance your loan immediately , however, your current lender will not likely allow you to refinance before the loan is 180 days old. You would have to refinance with a new lender.
How much does it cost to refinance?
A refinance loan will have closing costs just like any other home loan. Origination fees and a home appraisal will be charged, on average you will pay between 2%-4% when refinancing your mortgage.
How long does it take to refinance?
According to Fannie Mae’s report in 2017 the average time it took to complete a refinance was 46 days.
In Summary…
Refinancing your mortgage loan can potentially save you thousands of dollars over the life of the loan, but it’s not always a great idea.
There are costs involved in refinancing like closing costs and loan origination fees. You need to make sure you have a net positive benefit before deciding to refinance.
Top Reasons to Refinance a Home Loan
- Get a lower interest rate
- Refinancing out of an ARM into a fixed-rate
- Change the mortgage term (30-year into a 15-year)
- Lower monthly mortgage payment
- Make home improvements or repairs Remove mortgage insurance