It seems as though everyone is talking about refinancing these days. But is refinancing your mortgage actually beneficial for your unique financial situation? It depends.
Learn more about refinancing and how to make the best financial decisions based on the pros and cons.
What Does It Mean to Refinance Your Mortgage?
If you’ve never refinanced before, the concept can be pretty confusing. After all, you already have a mortgage on your home, why would you need another one? While refinancing may seem unnecessary, it could actually prove to be financially beneficial.
When refinancing your mortgage, you’re basically swapping your present mortgage with a new one that comes with a new interest rate, a new principal, and sometimes a different term. When you refinance your mortgage, you could choose to stay with your current lender or go with a new one depending on the rates and terms offered.
As a result, your new mortgage pays off your old one — leaving you with a single mortgage with a single and often lower monthly payment.
Pros and Cons of Refinancing Your Mortgage
Before you decide to refinance your mortgage, it’s important to understand the pros and cons so that you can make an informed choice.
Refinancing your mortgage may be able to shorten your loan term from 30 years to 15 years.
Refinancing your mortgage may be able to save you money over the term of your loan, thanks to lower interest rates.
Refinancing your mortgage may be able to save you money on your monthly payment if you extend the term of your loan through a refinance.
Refinancing your mortgage may not end up saving you money if you don’t plan on staying in your home long enough to recoup the closing costs.
Refinancing your mortgage can cause your monthly payment to increase if you’re shortening the term of your loan from 30 years to 15.
Refinancing your mortgage might not be worth the time and effort if you’re not able to significantly reduce your interest rate or monthly payments.
When Is It a Good Idea to Refinance Your Mortgage?
If interest rates have dropped and you’re able to secure an interest rate that’s at least 1% lower than your current rate, it might make sense to refinance your mortgage. Refinancing to receive a lower interest rate can likely save you thousands of dollars over the term of the loan.
With interest rates near record lows, many homeowners have decided to refinance their mortgage within the past couple of years.
Staying in Your Home for a Long Time
If you’re planning on staying in your home long enough to recoup the costs of refinancing. Refinancing isn’t free. Instead, you have to pay thousands of dollars in closing costs.
If you plan on staying in your home for more than a few years, that should be long enough for you to actually save money on interest, principal, and/or PMI after taking closing costs into account.
You Can Shorten the Loan Term
If you’re able to shorten the term of the loan through a lower interest rate, it definitely makes sense to refinance your mortgage. Depending on your current interest rate, it may be possible for you to refinance to a lower rate.
Then, you can pay off your mortgage quicker without having to pay more each month. However, this result isn’t always feasible, so make sure to crunch the numbers beforehand.
Converting Your Mortgage
If you want to convert your mortgage from an adjustable-rate mortgage to a fixed-rate mortgage or vice versa, it might make sense for you to refinance your mortgage. Most of the time, adjustable-rate mortgages start off with lower rates before increasing.
If you’re stuck with a high interest rate with an adjustable-rate mortgage, it might make sense to refinance to a fixed-rate mortgage with a lower rate. Alternatively, if interest rates are falling and you want to take advantage of this in the short term, it might make sense to refinance to an adjustable-rate mortgage for a few years before moving.
Positive Changes in Credit Score
If you’ve been able to build up your credit score since you first bought your house, you may want to consider refinancing to achieve a lower interest rate based on your stronger financial profile. Those with higher credit scores usually get lower interest rates, so if you’ve boosted your credit score above 750, it might be beneficial to refinance to get the best interest rate.
Getting Rid of Your PMI
If you’re refinancing to get rid of private mortgage insurance (PMI), then refinancing is definitely worthwhile. You’re required to pay PMI if your initial down payment is less than 20%.
For conventional loans, you are only required to pay PMI until you reach 20% equity in your home. After you have reached that 20% equity, it’s beneficial to refinance to get rid of PMI and lower your monthly payment.
If you’re looking to cash out on the equity of your home, then you may want to consider a cash-out refinance. A cash-out refinance allows you to tap into the equity of your home to pay for things like home renovations, medical bills, higher education — essentially anything you want.
So, if you have at least 20% equity in your home and need cash, a cash-out refinance might make sense. This type of loan often offers lower interest rates compared to other loans since you’re borrowing against your own equity.
How Much Does It Cost to Refinance Your Mortgage?
Unfortunately, refinancing isn’t free — you have to pay closing costs when you refinance your home — similar to the closing costs you paid when you initially purchased the home. These closing costs are used to cover the processing of the refinance, including the underwriting, appraisal, credit check, and other items.
While the exact closing cost rate varies by lender, you can generally expect to pay anywhere between 2 to 5% of the value of the new mortgage in closing costs.
So if you’re refinancing a loan that’s worth $250,000, you should be prepared to pay between $5,000 and $12,500 in closing costs. Since this is a pretty big range, make sure to get clear information from your lender about the breakdown of the closing costs. Don’t be afraid to negotiate with them.
In many cases, you may not have to pay the closing costs of your mortgage refinance up-front. Instead, you could choose to have the amount wrapped into your new loan. Just keep in mind that doing so will increase the balance of your loan and you will be paying interest on this amount — causing you to pay more at the end of the day.
How To Go About Refinance Your Mortgage?
If you’ve decided that now is the right time to refinance your mortgage, you need to act fast to take advantage of historically low interest rates.
When refinancing your mortgage, you can choose to stay with your current lender or you can find another one. If you’ve had a good experience with your current lender, it might be tempting to just stay with them for convenience’s sake.
It’s always beneficial to shop around with multiple different lenders to make sure that you’re getting the best rate and the best terms.
Step 2: Apply for a New Loan
The refinance application process is quite similar to the application process you experienced when you first purchased your home. Lenders will request documentation from you and check your credit history.
Lenders will need the information regarding your current mortgage. Additionally, your lender may request to see your two most recent pay stubs, your two most recent W-2s, and your two most recent bank statements. You also need to be prepared to provide them with your two most recent income tax returns.
If you’re married, they may also need to see documents related to your spouse’s income and finances. If you’re self-employed, be prepared to provide more documentation to prove your income.
Step 3: Lock In Your Interest Rate and Choose a Lender
Based on the rates you’ve received from different lenders, it’s time to make your final decision and move forward with the refinancing process. In the meantime, make sure to lock in your interest rate since they tend to change on a regular basis.
Depending on the lender, you may be able to lock in your interest rate for anywhere between 15 to 60 days. If you need to extend your rate beyond 60 days, you may have to pay for it.
Step 4: Go Through the Underwriting Process
Once you’ve chosen your lender, they initiate the underwriting process. During this time, they verify all of the financial information you presented when you initially applied. This process is the exact same thing that you went through when you initially purchased the home.
To ensure that this process goes smoothly, be sure to provide any and all requested documents and answer any questions your lender has along the way.
Step 5: Schedule a Home Appraisal
When you refinance your mortgage, you’re also required to complete a home appraisal to make sure that your home is actually worth the amount of the loan. Before the appraisal, make sure that your house looks its best. Give it a good cleaning and complete any minor repairs to put your best foot forward.
Step 6: Clone on Your New Loan
After the underwriting process is complete and your house has been appraised, it’s time to close on your new loan. At closing, you will go over the details of your loan, including your final monthly payments.
You will then sign your loan documents and pay any required closing costs. From there, your old loan is paid off, and you begin payments on your new loan.
Final Thoughts on Refinancing
While the pros and cons of refinancing may vary, right now, the pros outweigh the cons in most cases due to record low interest rates. If you have a good credit score, you may be able to secure an interest rate below, 3% depending on the type of loan.
If you’re looking for the best interest rates and terms, then you need to work with Vaster Capital. Vaster Capital is a premier bridge lender with extensive experience in the mortgage and real estate industries. Begin your application today.