Nearly 40% of homeowners across the United States are mortgage holders.
Many Americans cherish the American dream, and being a homeowner is a core part of that vision. As a result, mortgages to buy homes are a common occurrence. But what happens when you’re no longer happy with your current mortgage? Refinancing is an option many homeowners explore to find a deal that works for them.
If you’re wondering, “What is refinancing?” Here’s a guide to help you better understand when it’s most useful for you.
In simple terms, refinancing your mortgage is when you take out a new loan to replace your current mortgage. Most times, a homeowner will refinance their mortgage to take advantage of better interest rates.
When you refinance your mortgage, you reset the repayment schedule. For example, let’s say you took out a 30-year lease of which you had made repayment for five years. Once you take out a new mortgage (with a 30-year tenor) to replace the old one, your repayment clock resets to 30 years. However, there many options to reduce your loan term down to 25, 20, 15 years.
Some lenders offer flexible term programs that allow you refinance to an 18 year loan term or based on how many years you already have paid the current mortgage so that you don’t have to start over when you are almost done paying your home. This allows you to reduce your insterest rate an keep the loan-term short, making it a better option to pay your home faster.
At its core, refinancing your mortgage will look similar to how you applied for your first mortgage.
The only significant difference is in the first step where you will be asking different questions as you choose a mortgage lender. Unlike a first mortgage, the objective of refinancing is to either tap into your home equity or restructure your loan for better costs.
The restructuring can be to extend your loan term, get lower interest rates, or even switch to a fixed interest mortgage. Whatever the case may be, you first need to identify your primary need for refinancing.
With this in mind, you can then shortlist potential lenders to choose the best option. It doesn’t have to be the lender you got your first mortgage from. Before selecting, ensure you have at least three to four lenders to choose from.
Once your loan approval goes through, pay close attention to the terms and fees the new mortgage will attract. Sometimes hidden closing costs can make the deal prohibitive.
You can then continue making payments until you clear the new mortgage or refinance it.
As with any other loan, you need to weigh the pros and cons of refinancing your mortgage before making the move. Here are some signs to indicate that refinancing can yield good fruit.
The interest rate you get on your mortgage is critical to the viability of the loan. On average, interest rates on mortgages have dropped, historically speaking. For example, anyone who bought their home before the recession can likely look forward to a better interest rate.
In such an environment, taking out a second mortgage to access lower interest rates can be a great idea.
The rule of thumb is to go for refinancing if your interest rate will drop by at least one percentage point or more. There are exceptional cases, though, where a drop in less than one percent in interest can still make a sense and a financial difference.
The interest rate on your mortgage rides on two things – the prime rate and your credit score. Generally speaking, the better your credit score, the lower the interest you can get on the mortgage. Even an increase as tiny as one point can get your lower interest rates.
If your credit score has improved from when you first bought a house, refinancing your mortgage can be a good move. Potentially, you stand to benefit from getting a lower interest rate, which reduces your monthly mortgage payment amount.
If your credit score is not where you’d want it, you can improve it before looking for a second mortgage.
Cash-out refinancing can help you access liquidity to settle a big expense. With this kind of refinancing, you essentially apply for a bigger mortgage loan than the amount you currently owe. The difference between what you currently owe on your mortgage and the refinancing amount will be credited to your account as cash.
For example, say you have a $100,000 mortgage and want to refinance to the tune of $120,000. If your application is successful, the lender will send the $100,000 to the financier to clear your first mortgage. The remaining $20,000 will be credited to your account.
Cash-out refinancing often comes with a lower interest rate amount than a personal loan or a credit card loan. As a result, this becomes an attractive option when homeowners need a large sum of money to pay for something.
Has your income increased significantly, and you want to ready your mortgage over a shorter period? A shorter-term mortgage loan can help you save a bundle on interest costs.
For example, a homeowner who has a credit score between 750 to 860 and whose mortgage is for $100,000 over 30 years might expect a 2.8% APR. That translates to around $59,900 in total interest.
If this same homeowner decides to reduce their mortgage tenor to 15 years, without their credit score or APR changing, they can expect to pay roughly $37,000 in total interest. That’s a significant jump in savings than if their credit score were to go up.
The refinancing will give you a shorter-term loan for which you will pay more in monthly payments. You can use the extra income to offset the increased monthly mortgage payments, so you ultimately pay less in the long term.
Adjustable rate mortgages (ARMs) change depending on the type of loan you have and prevailing market conditions.
If your loan is about to adjust and you are uncertain about whether you can cover the increase in the interest rate, you can refinance using a fixed-rate mortgage.
If you desire to change the makeup or terms of your current mortgage, refinancing can be an option. However, you need to know when refinancing is viable and when it isn’t, to avoid making costly blunders. Take the time to ask, “What is refinancing?” to gain clarity for better decision making.
Are you looking for a mortgage? Market Place Mortgage wants to empower you with the mortgage that’s right for you. Talk to us today for transparent and ethical mortgage lending options.
