With the ever-changing state of the housing and financial markets, many homeowners consider a refinance mortgage to meet those changes. There are several reasons a homeowner may want to consider refinancing their home loan.
Homeowners can often reduce their interest rates with a home refinance. Just a 1 percent drop on a fixed-rate, 15-year mortgage of $200,000 could save as much as $17,000 over the life of your loan.
There are other reasons people consider a home loan refi. They may want to leverage their home equity for other pursuits, such as a business loan. A cash out refinance mortgage could help pay off higher-interest loans or pay for needed home renovations.
There are also good reasons not to refinance, and we’ll cover those, as well.
1. The Best Way to Refinance a Fixed Rate Mortgage
If your financial status has improved since you purchased your home, it may be time for to refinance your home mortgage. Improved credit scores, increased income, and lower debt-to-income ratio may mean you’ll benefit from a refi.
If you’re in a fixed mortgage and looking to refinance, improve your financial health first. This way, you’ll be able to get the lowest interest rates available.
There are several steps you can take:
Raise your credit score before applying.
Although lenders vary by type of loan, credit scores over 740 usually get the best rates.
Lower your debt.
If you’re planning to refinance, don’t get into more debt. If possible, pay off any car loans and lower the balances on your credit cards first. Get and keep your back-end DTI under 36 percent long before applying.
Increase your home equity.
The current value of your home will impact any interest rate offered you in a refinance mortgage. If your home is underwater (or barely treading), your best option may be a HARP loan. The longer you’ve owned your home, the more equity you will have.
Do your financial homework.
Make sure you have access to all the documentation you’ll need to refinance. Get copies of credit reports from all three bureaus. Be prepared with at least two years of tax returns, along with pay stubs and bank statements. If you’re self-employed, you may need more than two years.
Save money for the closing costs.
Although many lenders will cover closing costs for a refinance mortgage, estimate about 2 percent you’ll need in savings. Some lenders will cover it for you, if you pay a higher interest rate. Do the math and decide if it’s really worth it. You may be much better off just saving the money while you get the rest of your financial house in order.
Decide How you’ll refinance your mortgage.
Along with conventional loans, you may be eligible for an FHA, VA, or USDA loan for your refinance home mortgage. Weigh the options and shop around. Check with multiple lenders — or even a mortgage broker — before settling on the first name on your online search.
2. The Best Way to Refinance an Adjustable Rate Mortgage
Many homebuyers have decided to gamble on an adjustable rate mortgage in the past. This can work out for those who only plan to live in a home for a few years. However, home loan interest rates have stabilized at record low levels. Many find they’re staying in the same home much longer, due to economic stagnation. A savvy homeowner may want to lock in this rate until the end of the loan. You can refinance an adjustable rate mortgage to a fixed rate mortgage.
For some, ARMs have been a good tactic. However, adjustable rate mortgages (ARMS) are resetting to the highest rates since 2009. So, if your ARM is about to reset, it may be time to refi with a fixed rate mortgage.
You may be closer to retirement now, and facing a fixed income. It’s beneficial to know exactly what your out of pocket expenses will be. A fixed rate mortgage means a stable monthly mortgage payment.
On the other hand, you may be planning to keep your home a few more years. The life of the loan is nearly expired. In that case, you may not want to refinance your ARM. You may even want to find another ARM with a better rate for the duration.
In either scenario, getting your financial health at optimum peak is your first step. See the suggestions above.
3. Consider a Cash Out Refinance Mortgage
A cash out refinance mortgage is based on home equity, and the cash back can be used in a variety of ways. In a straight cash-out refinance mortgage, the owner is borrowing on their current equity to leverage the cash for other purposes. They may use it to start a business, do home renovations, or launch a world tour.
A cash-out refinance is a good idea if you can lower your interest rate. It may also be a good idea if your plans for the cash will increase the value of your home or add financial stability. However, if you can’t get a better interest rate and plan to renovate, you may be better off with a home equity loan or home equity line of credit (HELOC). With these, you have the option of paying them off quicker without affecting your home mortgage.
Another reason for a cash-out refinance might be to purchase another property. Investing in real estate is one of the best ways to build wealth. An all-cash purchase of a small rental home at a great vacation destination can also become a great retirement home.
Should you refinance to consolidate debt?
For some homeowners, a refinance mortgage that allows them to pay off debt is a good use of home equity. Nearly all Americans are in debt in one form or another. Home loans generally offer a much lower rate of interest than other loans. After all, why pay 12 percent on a vehicle loan when you can pay only 4 percent on a home loan?
In a designated debt consolidation refinance, the borrower may borrow up to 125 percent of the worth of their home. But, there are a few problems with consolidating debt with a home loan. It sounds like a good idea, but it reinforces bad habits. Once the vehicle has seen out its useful life, you’ll still be paying for it. Not only that, you’ll eventually have to buy another car. And you’ll probably have to get another car loan to do so. You’re right back in the cycle of carrying too much debt.
Another problem with this plan is that you’re wrapping dischargeable debt into a non-dischargeable financial instrument. What does this mean? In plain words, should your financial situation become truly dire, your credit card debt can be discharged under bankruptcy. If you’ve paid your credit cards off with your refinance mortgage, you’ll still be responsible for their payment.
In another case of hoping for the best and preparing for the worst, consider school loans. Should you become unemployed, a simple phone call can usually defer your school loan payments. It’s much harder to get a deferment on a mortgage. So, even though the interest rate on a school loan is a bit higher, wrapping it into your mortgage might not be a good idea.
4. Cash In Refinance Mortgage
A cash-in refinance mortgage allows homeowners to come to the closing table with a bigger down payment in order to improve the terms of their loans. Although it seems like an unlikely scenario, refinancing your home with a larger lump sum of cash can go a long way in improving your financial stability in the future. If you have it.
There are several reasons for getting a cash-in refinance:
1. To take advantage of lower interest rates in a home you’ll be keeping.
2. Planning before retirement to reduce out-of-pocket monthly expenses on a fixed income.
2. To reach an 80 percent loan-to-value ratio in order to avoid paying private mortgage insurance.
If you’re planning to stay in your home for many, many years, and you have the cash, you can reduce your out-of-pocket monthly payments quite a bit with a cash-in refinance.
5. Rate and Term Mortgage Refinance
A rate and term mortgage refinance reduces the length of your loan. Sometimes, it also offers a lower interest rate. It doesn’t change the amount you’re borrowing. Your loan is on the current balance of the loan.
The greatest benefit is earning equity in your home quicker with a 15-year loan than with a 30-year mortgage. Shorter term loans usually have significantly lower refinance rates.Your payment may go up slightly, but with a smaller interest rate. And your home will be free and clear much faster. You’ll also spend much less over the life of the loan.
On the other hand, you could refinance to extend the loan to 30 years. A rate and term mortgage refinance to extend the life would reduce your monthly payments. It’s always a good idea to shorten the life of a loan, but sometimes life has other plans. You may need more disposable income to take care of a family member. You may also feel you’ll get a better rate of return from other investments.
There are downsides, however. You’ll spend many more years paying down your home and reduce its liquidity. You’ll also pay more in interest over the life of the loan, even if you reduce the rate.
When Not to Refinance Your Home
According to Investopedia, refinancing your home can cost from 3 to 6 percent of the principal. It can take years to recoup the cost of refinancing. If you’re not planning to live in the home more than a few years, it may be a poor investment
Refinancing your home to shorten the term may seem like a wise long-term move. However, if you’re like most Americans, you’re already barely living within your paycheck. It makes no sense to refinance a home to cut the length of the mortgage if it means you can’t afford to maintain it. (Or even heat it!) A refi for a shorter term can mean a lower interest rate, but it will increase your monthly payments. If you don’t have the budget flexibility you need with your 30-year mortgage, you’ll have even less with a 15-year mortgage.
If you aren’t creditworthy, don’t think about refinancing. The economy has played havoc with most of Americans over the last decade. With record unemployment, even the most financially reliable people have a few bad dings on their credit history. If your credit score has dropped or your DTI has risen since you purchased your home, it may not be time to refinance it. Check your job history, too. Lenders want to see long-term stable employment.
Home prices across the country have generally recovered since the Great Recession and Housing Crash. However, you may still be underwater. If your home has dropped in value, it may not be time to refinance. Check the comps in your neighborhood to get a good idea of home values to expect. They’re usually available on the property appraisers website in your county.
A home refinance mortgage can be an excellent tactic for lowering the cost of your home. It can also help you increase its value. The options can seem overwhelming, but are worth looking at. Most lenders will have a mortgage refinance calculator on their website to crunch the numbers. Bankrate.com is also an excellent resource with a number of calculators for home buyers.
The first step is to identify your long-term financial goals. The second is to honestly assess your financial fitness. Nothing creates wealth in the U.S. like investing in real estate. Even when it’s your own home. And the right refinance mortgage may be your first best step.
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