It is understandable to feel confused when refinancing your mortgage. If you’re in that situation, here, we are going to explain what mortgage refinancing is and how it works. When you are done reading this, you will know the right decision to make.
What is mortgage refinancing?
Mortgage refinancing is the process of substituting your current mortgage with a new one. Your new mortgage can include a different interest rate, loan term, and monthly payment schedule than your previous mortgage.
People refinance their mortgages for different reasons, such as reducing their monthly payments, getting a lower interest rate, or borrowing some money from their home equity.
How does refinancing work?
Refinancing works when you use the money from your new mortgage to pay off your existing mortgage. This may be achieved by taking out a new loan with a different lender or working with your lender to renegotiate the terms of your existing loan.
During the refinancing process, you will be required to repeat the application process, which is comprised of a credit check, home appraisal, and income verification.
How to refinance a mortgage
- Understand Your Current Mortgage
- Check Your Credit Score
- Shop Around For The Best Rates
- Calculate Refinancing Costs
- Factor In Closing Costs
- Undergo The Underwriting Process
- Receive Loan Approval and Closing Disclosure
1. Understand Your Current Mortgage
Before you start thinking about refinancing your mortgage, you should first take a good look at your mortgage. What is your current interest rate? What is the type of loan you have? This knowledge will help you understand whether refinancing is to your advantage or not.
2. Check Your Credit Score
The most important factor that will determine the interest rate you will pay when refinancing your mortgage is your credit score. Before applying, it is advisable to check your credit score and take steps to improve it if the need is there.
3. Shop Around For The Best Rates
Just as when you got your mortgage initially, it is necessary to shop around and compare loans with different lenders. Do not jump on the first offer that comes your way; weigh your options and choose a rate that is most suitable for your financial situation.
4. Calculate Refinancing Costs
Study the closing costs related to refinancing: appraisal fees, origination fees, title insurance, and possible prepayment penalties. Analyze whether the possible savings from refinancing exceed the down payment costs.
5. Factor In Closing Costs
The closing costs when refinancing your mortgage can amount to thousands of dollars. Don’t forget that these costs need to be included in your refinancing decision. Decide whether the savings outweigh the costs.
6. Submit The Refinancing Application
Fill out a refinancing application with the chosen lender, providing authentic data about your financial status, work history, and property details. Expect to have your credit score examined, and bring documents to prove that you qualify for refinancing.
7. Undergo The Underwriting Process
The lender will analyze all your credit history and financial documents and then check your creditworthiness and the risk associated with refinancing. Collaborate with the underwriting process by promptly providing any documentation or information that is requested.
7. Receive Loan Approval and Closing Disclosure
If the mortgage is approved, the lender will then issue a loan commitment letter that will outline the terms and conditions of the refinanced mortgage.
Carefully go through the closing disclosure to check for the accuracy and make sure that you understand all the terms of the loan (including the closing fees and any additional charges).
Reasons for mortgage refinancing
People choose to refinance their mortgages for different reason. Some of the reasons include the following:
1. Reduced Interest Expenses: Borrowers can reduce their interest expenses greatly over the remaining term of their loan, hence, their savings increasing quickly.
2. Access to Home Equity: Cashout refinancing provide homeowners the opportunity to use their home equity for different reasons, such as home improvements, student loan consolidation, debt consolidation, or emergency funds, and so it can be an effective way of obtaining liquidity.
3. Debt Consolidation: An efficient way to consolidate borrowers’ finances may be by onsolidating high-interest debts, like those accrued on credit card balances and personal loans, into a lower-interest mortgage. This can result in lowering overall interest costs.
4. Adjusted Loan Terms: By refinancing, borrowers can change the terms of the loan; for instance, they can change from an adjustable-rate mortgage to a fixed-rate mortgage or decrease the loan term so as to increase the equity and pay the mortgage off earlier.
5. Removal of Private Mortgage Insurance (PMI): If a borrower’s home equity reaches a point where it is over 20% of the property’s value, refinancing would prevent the need for private mortgage insurance (PMI), therey, there would be a reduced monthly payment.
Pros and cons of Refinancing
Pros of Refinancing
i. Lower Monthly Payments
A refinancing act can be one of the many ways to reduce your mortgage payments. For instance, it may be possible to lock in lower interest rates or a longer repayment term. In this way, you may improve the cash flow of your household and make housing costs more manageable.
ii. Access to Home Equity
With cash-out type of refinancing, you can pull out money from your home equity by taking more than the amount you have on your current mortgage. This can include, debt consolidation loans, education loans, and other financial needs financing options.
iii. Adjusted Loan Terms
Refinancing can be done with some flexibility, like when one wants to change from an adjustable-rate to a fixed-rate mortgage or reduce the loan term.
Adjusting the loan terms will allow you to reach financial goals of your choice, like shortening the mortgage term or fixing interest rates.
iv. Debt Consolidation
Consolidating high-interest loans into one mortgage through refinancing can ease repayment and save the money that would have been used for interest expenses. With this, it can help cancel debt consolidation, and also, enable you to manage your finance.
v. Improved Credit Score
Timely payments on a refinanced mortgage could positively affect your credit score as time passes, ultimately leading to better health and a better credit score for your finances.
Cons of Refinancing
i. Closing Costs and Fees
Typically, refinancing involves upfront closing costs and charges such as appraisal fees, origination fees, title insurance, and potential prepayment penalties. These expenses can be around thousands of dollars and may eat up the real savings that can be achieved by refinancing.
ii. Lengthened Loan Term
It may reduce your monthly bills through refinancing and extending the term, but at the same time, the total amount of interest paid over the life of the loan will increase. Take time to consider whether the long-term cost exceeds the short-term savings.
iii. Potential Rate Increases
In refinancing from a fixed-rate mortgage to an adjustable-rate mortgage (ARM) or a variable interest rate loan, you will be at risk of potential rate hikes. That will likely translate to larger monthly payments in the future.
iv. Risk of Foreclosure
If, through cash-out refinancing, you borrow against the equity in your home, then you are raising the amount of debt secured by your property. Missed payments on the refinanced mortgage can lead to the loss of the home and foreclosure.
When should you refinance?
Deciding when to refinance your mortgage requires taking into account your financial goals and your current situation. If interest rates on mortgages have decreased significantly since you got your current mortgage, it might be the right time to refinance to secure a lower interest rate.
You should also take into account your financial situation and credit score before determining whether to refinance. The good news is that if you have done well with your credit and your credit score is better than it was when you originally got your mortgage.
In addition, you may qualify for a lower interest rate when you refinance. But if you have a lower credit score or a high amount of debt, the option of refinancing may not work for you.
Read also:Refinancing Your Mortgage: When And How To Do It Right
Conclusion
Mortgage refinancing could be one of the ways homeowners use to save money, access home equity, or refine their loan terms.
By learning the principles of mortgage refinancing and weighing the pros and cons of refinancing, you can make a better decision to either refinance or not. However, you may decide to hire a mortgage advisor to help you with the process.
