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.
- Reduce risk with fixed-rate loan: Adjustable Rate Mortgages (ARMs) usually have much lower interest rates initially than 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 ARMs 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 more money on monthly payments over a fixed rate.
- Reduce mortgage terms: To save money by changing the length of your 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 6.0 percent for 30 years with a fixed-rate loan at 5.5 percent for 15 years. A 30-year loan at six 6.0 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 in total interest over the life of the 15-year loan.
- Cash-out refinancing: Need some money for a new bathroom or a kitchen remodel? What about for the kids’ tuition or an emergency or to pay off other debts? Cash-out refinancing can free up cash by borrowing against your equity ( i.e. the difference between your home value and the total amount of money owed on the home) in your home. Cash-out refinancing also means borrowing more than what you currently owe on your home. Taking cash out to consolidate 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.
- 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:1) When you first purchased your home, your down payment creates immediate equity. 2) Each month, a portion of your mortgage payment reduces the original loan balance. 3) You gain equity if the value of the home goes up (either because of improvements in the home or because of appreciation). 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), provided by the lender at the time of refinancing. If you’ve seen a decrease in home value and you are 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 Conforming Loan versus a Jumbo loan – Your refinance interest rate options will vary depending on whether you have a conforming loan amount or a jumbo loan amount. 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. In some cases, conforming loan rates are lower than jumbo loan rates. These loan limits are updated every year and oftentimes increase as home values increase. Therefore, if you originally had a jumbo loan, and the conforming loan limit has increased, your current loan amount could qualify for a lower conforming loan rate. Check the Federal Housing Finance Agency website for current loan limits.
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 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 the latter years of a loan and refinance, the amortization process starts over, and even if the monthly payment drops, 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. Consider if refinancing is worth it, if you 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.