Welcome to the guide to mortgage refinancing!
Guide to mortgage refinancing – what it is, what it could do for you, and when you should do it?
You learned loads about mortgages, lenders, and loans when you first purchased your home, but it’s easy to forget all the technical stuff surrounding this essential topic. All you know is you had to turn in a whole bunch of different documents to various people, get approvals, sign papers, and voila– you were clear to close on the house!
Lots of people talk about “refinancing” and you’ve been too shy to say you have no idea what they’re talking about. No worries, reader! We’ve put together this quick guide about refinancing so you can learn what it is, what it could do for you, and when you should do it.
Guide to mortgage refinancing – what is refinancing?
The terminology here makes it sound like you’re restructuring your mortgage around new financial data. In essence, that’s sort of what’s going on here.
In actuality, you are replacing your current mortgage with a brand new one. Your lender will use the new mortgage to pay off the existing one, leaving you with one loan and one payment to keep track of.
Since you’re essentially starting over with a new loan, it’s not necessary to stick with your current lender. Finding a great deal somewhere else is actually one of the things that may make a refinance worth it.
What could refinancing do for me?
People refinance for a number of reasons.
1. Changing your loan term
The biggest reason folks end up refinancing their mortgage is to save on interest. Interest is the reason that your $300,000 home will cost substantially more in the long run, and the sooner you pay off the loan the better.
For this reason, some people will refinance and change their 30-year mortgage into a 15-year mortgage so they pay it off sooner. This will result in a higher monthly payment but, with less total payments and possibly a lower interest rate, the lifetime expenditure will be much less.
2. Lower your interest rate
Perhaps the biggest reason people refinance is to lock in a lower interest rate. Locking in a lower rate guarantees you pay significantly less interest over the course of the mortgage’s lifetime.
Generally, you should consider refinancing if the national average drops by one-half to three-quarters of a percentage point. If you are able to lock in an interest rate that is lower by a percent or more, it’s crucial to capitalize.
3. Cash out on your equity
Cash-out refinancing is another option. Assuming your home has increased in value over the course of your current mortgage, you are able to replace the original loan with a bigger mortgage and pocket the difference as cash.
People choose to do this when they need cash on hand to fund home improvement projects, consolidate high-interest debit, or finance other ventures thanks to the comparatively low interest rate you’ll receive when comparing this debt to other loan types.
We recommend reviewing the tax implications or consulting a CPA prior to pursuing a cash-out refinance, however, just to make sure you understand specifically what will be required of you.
4. Eliminate PMI
Some folks scrimp and save to come up with the 3.5% down payment for their FHA loans. Unfortunately, the big downside to paying less upfront is that your lender will tack on PMI, or private mortgage insurance, that you must pay on top of your other monthly payments until you reach 20% equity and refinance.
For those stuck paying PMI every month, it’s important to refinance immediately once you reach 20% equity so you could eliminate this extra charge before it drains your pocket even more.
Guide to mortgage refinancing – when should I refinance?
When you should refinance depends on a variety of factors, including:
•Current market trends
•Your financial health
•Your break-even point
•If you are paying PMI
Immediately after closing, the market will be in very similar or identical conditions as when you originally secured your first mortgage. Because of this, there’s little upside to refinancing immediately. The market needs time to change.
You’ll want to keep an eye on interest rates specifically, as interest is one of the biggest factors that will contribute to the grand total of what you spend on the home. Seeing a big drop in the national average could award you with loads of savings over time.
Generally, if the interest rates fall by one-half to three-quarters of a percent, it’s a good time to consider refinancing. Dropping by one or even two percentage points, therefore, is an excellent time to refinance as well.
We recommend using a mortgage refinancing calculator to determine your break-even point before fully committing. Using actual numbers lets you know definitively that it’s worth it to refinance.
If you are paying PMI and have finally attained 20% equity, we recommend refinancing as soon as possible. You will likely enjoy other perks like lower interest rates and lower monthly payments, but eliminating the PMI immediately is imperative.
Guide To Mortgage Refinancing – what are the downsides to refinancing?
Up to now, it seems like refinancing is this magical way to save you money. Don’t get us wrong. Refinancing could save you loads of money in the long term, but there are some downsides associated with it.
Closing costs
As with your original mortgage, you’re required to pay closing costs to seal the deal. Closing costs, on average, will fall between 2% and 5% of the total loan amount. Assuming you need a $300,000 loan and land in the middle of that range, you’ll be paying approximately $10,500 upfront and you’ll need to recoup that before you actually enjoy any savings.
For this reason, it’s crucial to ensure you know your break-even point and plan to stay in the house past this time. Selling before reaching that point will result in a loss, even if the short term savings made it seem like you did just fine.
Hard credit inquiry
Another less significant but notable downside of refinancing is that your lender will pull your credit score. A hard credit inquiry will cause that score to drop a few points, albeit temporarily, so it’s ill-advised to rack up one of these every year unless there’s a massive fluctuation in the market and you stand to benefit big time.
Guide to mortgage refinancing – final thoughts
Refinancing is often a great idea to save yourself money in the long run, but there are some things to keep in mind when deciding if it’s the right time and right course of action for you.
When in doubt, consult a financial expert, your mortgage lender, or a real estate professional to determine if it’s the right move for you.
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