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There are many reasons to refinance your home. Maybe you qualify for a lower mortgage interest rate or want to cash-out equity to make home improvements.
Whatever the reason, there are pros and cons to refinancing your home mortgage.
What is a Home Refinance?
A mortgage refinance is when you take out a new loan to replace your current mortgage. You can do this through a mortgage lender. It doesn’t have to be the same lender you used for your original mortgage.
The process to refinance is less complicated than getting a mortgage, but it still takes about 30-days to close.
Reasons to Refinance
You can refinance your home for many reasons. Some of the most common include:
- Lower interest rate
If the mortgage interest rate you qualify for has lowered significantly from your you might consider a refinance. The general rule of thumb is to consider it if the interest rate you qualify for is two points lower than your current rate.
A lower interest rate can decrease your monthly mortgage payment. It can also save you money over the life of your loan, depending on the other fees of refinancing.
- Change loan length
In some cases, you can refinance because you want to change the length of your loan term. Usually, you would do this to switch to a shorter-term length to pay off your mortgage faster. For example, if you have a 30-year-fixed mortgage you can refinance into a 15-year-fixed loan. Your payment will likely go up, but the loan paid off in less time.
However, if you are having trouble making monthly loan payments you could refinance to a longer mortgage term. With the longer loan term, you will pay more interest over time and the overall cost of the loan will be much higher, but you will have a lower monthly payment.
- Switch to a different type of mortgage
A loan refinance can switch the type of mortgage loan you have.
FHA loan to conventional
One of the most common is to switch from an FHA loan offered by the Federal Housing Association to a conventional loan. FHA loans don’t require a large down payment like some conventional loans and are popular with first-time homebuyers.
However, with an FHA loan there is required mortgage insurance. If you have gained more equity in your home, you can refinance to a conventional loan to eliminate the monthly insurance payment.
Adjustable-rate-mortgage (ARM) to a fixed-rate
An ARM is a popular option for some because of the low introductory interest rates. However, when the initial term ends, there is a possibility of the interest rate skyrocketing, depending on the current market. So, if you are close to the end of the initial loan term, or your next rate adjustment, you might qualify to refinance into a fixed-rate loan. In a fixed-rate loan, the interest rate stays the same over the entire period of the loan.
- To take out cash from home equity
If you have enough equity in your home, you can do a cash-out refinance. In this case, a new mortgage takes the place of your old one, but for a higher amount to include the amount of cash you withdraw. Lenders will usually only let you cash-out an amount that will still leave you with 20% equity in your home.
A cash-out refinance can be beneficial if you have home improvements or repairs you want to complete.
- Eliminate mortgage insurance
If you have less than 20% equity in your home, some lenders require you to hold Private Mortgage Insurance (PMI), which is a monthly cost. If you have been paying down your mortgage and go over the threshold of required equity, you can try to refinance into a new loan where PMI is not required.
- Remove someone from the loan
You can refinance if you want to remove someone from the mortgage. This might be because of divorce or falling out with a family member.
What Are the Different Types of Refinancing?
There are several types of refinancing available. Understanding some of them can help you navigate the process and understand what type of refinancing you might qualify for.
Rate and Term
A rate and term refinance is when you want to change your loan term or interest rate. You will need to qualify for the new loan and rate like you did for your original mortgage.
You can apply for a streamline refinance if you have a government backed loan like an FHA loan or a VA loan offered by the Veterans Administration. For this type of refinance, you won’t need a new appraisal and you don’t have to go through the full underwriting process. The timeframe for approval is shorter than a traditional rate and term refinance.
As discussed above, this type of refinance is when you have equity in your home, and you want to use a new mortgage to get cash.
How Do I Decide if I Should Refinance?
Only you can decide if it is the right time to refinance. Here are some questions to ask yourself if you are considering refinancing your mortgage:
- How much home equity do you have?
If you are refinancing for a cash-out, you will need to know how much equity you have. Equity can also qualify you for a lower interest rate that you might not have qualified for with your original mortgage.
- What is your breakeven point?
Refinancing has costs involved. There are closing costs and other lender specific fees. Sometimes the costs are rolled back into the mortgage, but you are still paying them by the end of the loan term. To figure out your breakeven point see how much the refinance will cost and compare it to your monthly payment after your savings from a new interest rate.
- Why are you refinancing?
It is generally not a good idea to refinance to take out cash for paying off debt, saving for a new home, or for something like a lavish vacation or luxury car. If you refinance for these reasons, your home is ultimately being used for collateral.
Refinancing to get cash for home improvements isn’t as risky. The work you put into the home will likely increase its value. The interest rate for your cash-out refinance will also be lower than a home improvement loan.
- How long do you plan to live in your home?
If you are planning to move within the next few years, it might not make sense to refinance. Once you add up the costs of refinancing, the amount you save by a lower interest rate probably won’t be worth it in the long run.
- What is your credit score?
If your credit score is better or worse than when you were approved for your original loan, that can impact a refinance. If your credit is better, you can probably get a better rate, but if it has gone down, it might not be a good time to consider refinancing.
Frequently Asked Questions:
Here are some of the most common questions we see about refinancing a home.
- How often can I refinance my home?
There is no limit on how many times you can refinance a mortgage. However, lenders might have limits of their own. It is also important to consider the costs of refinancing. The more times you refinance, the more costs you will have to pay.
- What is a good interest rate to refinance into?
Generally, an interest rate that is two points less than your current rate is worth refinancing for. But every situation is different, and, in some cases, you can refinance for a one percent, or even half point, decrease. It depends on your overall financial goals and your reason for refinancing.
- Can I refinance if I don’t have home equity?
The ability to refinance if you don’t have equity is limited. There are certain circumstances where a lender might approve a refinance like changing to a shorter loan term or if you move to a more stable type of mortgage.
- How long does it take to refinance?
Refinancing can take over a month. The exception is for a government backed loan like an FHA or VA loan, where you qualify for a streamline refinance. A streamline refinance does not go through an appraisal and have a less extensive underwriting process than a traditional mortgage.
- What information will I be asked for when I refinance?
The information needed to refinance is similar to a mortgage approval. The lender will look at:
- Credit score
- Tax returns
- Proof of employment
- Bank records
- W-2s or 1099s
- What are the fees for refinancing?
Closing costs are usually 2% to 5% of the refinanced loan amount. Lenders might also charge additional fees.
The Bottom Line
The bottom line is the decision to refinance depends on your specific situation. If you plan to stay in your house a long time and qualify for a much better interest rate, it might be worth it. You can also shorten your loan term and pay off your house faster. On the other hand, if you extend your loan term you might end up paying more interest over the life of the loan even if you now have a lower rate.