Refinancing a mortgage in today’s economic climate can seem like an overwhelming task. But refinancing can mean substantial savings on your monthly payments, an overall cost reduction or even a risk reduction. Did you know that an average American refinances his or her home loan once every four years?
Get the basics on mortgage refinancing and find out if refinancing is right for your financial situation.
What is mortgage refinancing?
A refinance mortgage is a loan secured by residential real estate that is used to pay off your existing mortgage and/or to access equity in your property.
Why should you refinance?
The bottom line to refinancing is saving money, but there are a few ways to do that.
- Reduce interest rate: If you are refinancing to get a lower interest rate on your mortgage the cost savings can be significant. However, to truly assess the savings impact you must consider not only the reduction in monthly payments but also if the savings generated by the lower interest rate is enough to cover the closing costs of the new loan as well as the difference between the time left on your existing loan vs. the new mortgage.Of course, this type of a calculation is rather complex, but we have the right tools for you. Credit Sesame uses patent pending analytics to assess your financial situation and help you determine if mortgage refinancing is right for your time horizon. Sign up completely free to try it out.
- Reduce risk with fixed-rate loan: Adjustable Rate mortgages (ARMs) usually have much lower interest rates initially than the Fixed Rate mortgages. However, once the variable rates start, depending on the economic conditions, the payments may rise significantly. Some homeowners may prefer less risky loans, like the Fixed Rate mortgages that have consistent monthly payments for the duration of the loan. Choosing between a variable and fixed loan refinance is completely subjective and depends on the individual’s risk tolerance. If you are comfortable with variable payments, refinancing to an ARM mortgage may save you money on monthly payments.
- Reduce mortgage terms: To save money by changing the length of you mortgage, you may have to take on higher payments, but in the long run, you will be paying less in interest. Compare the total interest costs for a fixed-rate loan of $200,000 at six percent for 30 years with a fixed-rate loan at 5.5 percent for 15 years.A 30-year loan at six percent will have a lower monthly payment of $1,199, but over the course of the loan, the borrower will pay $231,640 in interest. On the other hand, a 15-year loan at 5.5 percent will cost the borrower $1,634 monthly, but over the life of the loan, the interest paid will only be $94,120. So, by paying $435 more each month, this borrower would save $137,520.
- Cash-out refinancing: Need some money for a new bathroom or a kitchen remodel? What about for the kids’ tuition or an emergency? Cash-out refinancing can free up cash by borrowing against your equity (read: ownership) in your home. Cash-out refinancing means borrowing more than what you owe on your home to cover existing debts. Consolidating your debts into your mortgage can help you pay off all those bills and pay less interest on them. One caveat: by doing this, you will be creating a longer term of payment, which typically leads to more interest being paid on your mortgage over time. Make sure to do the math before refinancing and find out if you feel comfortable with the savings.
Who should consider a mortgage refinancing?
Due to the aftermath of the housing crisis and the delicate state many banks are in, it is harder than ever to refinance your home loan. However, certain factors can play to your advantage:
- Excellent Credit
Those with a credit score of 720 or higher will be eligible for the best interest rates. Check your credit score for free and get today’s real mortgage rates tailored to your credit situation on www.CreditSesame.com. Also, check out how to increase your credit score quickly.
- Home Equity
Those with 20 percent or more equity in their home will be most eligible for refinancing. Equity is ownership. There are three ways to acquire equity. The borrower can buy it with the down payment, pay the premium down on the home, or get equity if the value of the home goes up (either because of an investment in the home or because of inflation in home prices). A lender will require the current appraised value of the home before refinancing.In some cases, if a borrower’s equity is less than 20 percent, that person can still be considered for refinancing if he or she gets a private mortgage insurance (PMI). Unfortunately, PMI is no longer available in areas where home values have seen the biggest hit. If you’ve seen a decrease in home value but you’re still eligible for private mortgage insurance, before refinancing, you should weigh the monthly cost of the insurance premiums against the expected savings on monthly payments to assess whether or not the PMI mortgage is a viable option.
- A Free-and-Clear First Mortgage
Many homeowners use their equity in their home to receive loans or lines of credit. This borrowing on equity is often known as a second mortgage. In the past, having a second mortgage was not seen as a hindrance to refinancing the first mortgage. The lender for the refinanced mortgage would ask the lender for the second mortgage for permission to subordinate the second mortgage. This means the new refinanced mortgage would take precedence over the second mortgage.However, in today’s economy, home equity loans and lines of credit are considered riskier that first mortgages, so many lenders will not refinance with you until those encumbrances are paid off.
- A Conforming Loan
Even if you have excellent credit, 20 percent or more in equity and no second mortgage, if you have a jumbo loan, or loan that exceeds $625,000, instead of a conforming loan, you may not be able to refinance to save money as the interest rates for jumbo loans have remained high.On the other hand, the lowest interest rates can be found for loans of $417,000 or less, known as conforming loans. Conforming loans are those that government-sponsored mortgage giants Fannie Mae and Freddie Mac will buy in a secondary market. That makes conforming loans less risky for lenders. If you have a conforming loan, you are better suited for refinancing.
When to consider a refinance?
- you have a mortgage with a rate above current market rates;
- you have an adjustable rate and you want to reduce payment risk by fixing your rate for a longer period of time;
- you have equity in your property and you need access to cash;
- you want to improve cash flow by lowering payments.
When should you absolutely not refinance?
For some homeowners who meet the above criteria, refinancing is still not a good idea.
- If the borrower has had the mortgage for a long time
As a borrower pays off their loan, more and more of the payment goes toward the principal rather than the interest. This concept is known as amortization. If you are in in the latter years of a loan and refinances, the amortization process starts over, and the monthly payments will go back to paying more interest than principal, costing you more money in the long run.
- If the current mortgage has a prepayment penalty
A prepayment penalty is a fee lenders charge for paying off your loan early, including refinancing. If you are refinancing with the original lender and have a prepayment penalty clause, ask if it can be waived. If not, assess the extra time it will cost to pay off this penalty against what you expect to gain in monthly savings.
- If the borrower is planning to move in the next few years
In this case, the savings from lowered monthly payments might not exceed the costs of refinancing. Use our break-even calculator to determine if refinancing is worth it, if there’s move in the near future.
Find out if you should refinance on Credit Sesame
Get a complete picture of your credit, including a free credit score, and find out real mortgage rates you qualify for based on your financial situation. Credit Sesame’s patent pending analytics analyzes your financial picture against the top bank’s mortgage rates daily and notifies you once you qualify for a refinancing option fit for your credit needs. Sign up today.