If you’re a homeowner with a mortgage, there is a likely chance that you will refinance your home at least once throughout the life of your loan. There are several reasons to refinance and it often provides many benefits to you, the homeowner. But, understanding the basics of refinancing can be difficult to break down, especially if you’ve never refinanced before.
That’s why it’s so important to do your research before making your decision. There are also a few different factors to consider in your refinance and not knowing the difference could cost you a lot of money and/or wasted time.
Whether you’ve recently thought about refinancing or you’re ready to refinance but you have questions, you’re in the right place. Here, we’ll discuss all the basics you need to know. Keep reading to learn more.
The Basics of Refinancing Your Home
Refinancing can be just as demanding and confusing as purchasing or selling a home. It can also be a real breeze if you have an amazing loan officer. He or she can help you make sense of the paperwork and associated fees and walk you through the refinance process with ease.
Types of Loans for Refinancing
Before you can refinance, you should know what type of loan you currently have and what type of loan you intend to obtain. It’s also important to know the differences between each type of loan. Let’s take a look at your options.
VA Loans
VA loans allow for 100% financing of the purchase of a home without any money down. The VA also has one of the most simple refinance options available, the Interest Rate Reduction Refinance Loan (IRRRL – pronounced “earl), which as the name suggests, is a streamlined loan process with the sole purpose of reducing your interest rate and requiring very little documentation. We love the simplicity and benefit this loan provides our veteran clients and friends.
FHA Loans
FHA loans require an upfront and annual Mortage Insurance Premium, also known as MIP. Because FHA allows a higher debt to income ratio and a lower downpayment, the insurance is there to cover the additional risk to the lender while allowing a lower barrier to entry for first time home buyers. If you’ve had your loan for a few years and believe the equity is there, you may consider refinancing to a Fixed Rate Mortgage with no MIP.
Conventional Fixed Rate Mortgages
Fixed rate mortgages are just as they sound. The rate remains fixed throughout the life of the loan. The most common reasons for refinancing a fixed rate mortgage includes accessing cash and lowering the interest rate, or to eliminate Private Mortgage Insurance (PMI) which is required for loans with less than 80% Loan to Value (LTV).
Adjustable Rate Mortgages (ARMs)
An adjustable rate mortgage, alternatively, only remains fixed for a short period of time, typically two to five years. After that, the rate becomes adjustable according to the market and the terms of the loan. Many people refinance ARMs in order to avoid their loan adjusting to a significantly higher rate, resulting in monthly payment they can’t afford.
The Mortgage Refinance Process
Once you determine what type of loan you currently have, you may begin preparing for your refinance. Here’s a checklist of things you’ll need to know to get started.
Your Credit Score
Knowing your credit score up front will give you a leg up as you begin shopping for loan officers and prime rates. If you’re shopping with multiple brokers or lenders you should be sure to have them pull your credit around the same time. Multiple inquiries spread out over too long a period of time can reflect negatively on your credit report and lower your score.
Home Value
What is your home worth? Are you planning on taking cash out? Even if you’re just refinancing to a different loan type or a lower interest rate, knowing the value of your home is essential. Zillow is a fine resource to get a rough estimate but has its flaws (for example, it doesn’t know the condition of your home, whether or not it has an amazing view, etc.). To obtain a more accurate home valuation, contact a local real estate agent and ask them for a Current Market Analyses (CMA), which is much more reliable.
Knowing exactly what you hope to achieve with the refinance of your home will make a big difference in the proceedings of the loan. Your lender will appreciate your honesty and do their best with that information to help you obtain the right loan.
Rate Shopping
The best way to prepare for a refinance is to use a mortgage loan calculator to determine what your new payment with be using current rates. Keep in mind that most rates advertised online are not as cut and dry as they seem. Always ask a lender for a full closing cost worksheet that reflects your credit score, debt-to-income ratio and loan-to-value when evaluating different rates.
A typical closing cost worksheet includes but lender and origination fees, processing fees, appraisal fees, and title and insurance costs. You will also be able to see if they are quoting discount points, which is a fee that you pay in order to lower your interest rate.
Risks of Refinancing
Always ask your lender how long it will take you to break even on the cost of your new loan. Do you only plan on keeping the home another year? It may not be worth the closing costs if you are only hoping to lower your monthly payment as it could take some time for the savings to outweigh the expenses.
Also, be sure to check with your current lender to make sure there are no fees or fines associated with refinancing out of your mortgage, such as pre=payment penalties.
The Major Benefits of a Refinance
The benefits of refinancing a home don’t stop at changing loan types or lowering interest rates. Here are some common reasons and benefits of refinancing for homeowners.
Lower Monthly Payments
Perhaps one of the greatest benefits of refinancing a mortgage is the potential to lower your monthly payment. Alternatively, you could keep the same or minimally higher payments and significantly shorten your loan term, which allows you to pay off your mortgage faster.
Access to Cash
Need cash to pay for your daughter’s wedding or your son’s last year in college? Maybe you have some home improvements that are out of your current budget. Refinancing gives you the option of taking equity out of your home to make larger purchases or investments.
Consolidate Debt
You may want to use that cash to pay off debt. Just be careful to weigh the costs of your refinance over the life of the loan compared to your other debt to be sure you’re really saving money.
Reduce Interest
And, of course, reducing your interest rate is a great reason to refinance. Not only can it have an impact on your monthly payment, but you’ll pay less over the life of your loan.
Final Thoughts
The home basics of refinancing don’t have to be so confusing. Set your goals, get your credit score in line, and find a loan officer you can trust to have a seamless experience. And, keep these tips in mind as you journey through the process in order to have something to reference when you’re unsure about anything.
If you have questions or would like to speak with a loan officer, don’t hesitate to contact us! Our goal is to help you make smarter financial decisions.
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