Think you’d benefit from a refinance? You might! A refinance can allow you to change the terms of your mortgage loan to make it easier to pay your bills or get cash out of your equity. You may want to consider a few of the costs involved when you apply.
Why Do Homeowners Refinance?
There are four major reasons why you might want to refinance your home loan. You may want to lower your interest rate, change your loan’s term, consolidate debt or take cash out of your equity. Let’s take a look at each of these motives in more detail.
Lower Your Rate
You may be able to save thousands of dollars, particularly if you can refinance to a lower interest rate. This is especially true if you keep the same term on your loan.
For example, if you refinance a 15-year loan into another 15-year loan, a lower interest rate will decrease your monthly payment. However, keep in mind that taking a lower interest rate won't reduce your taxes or insurance rates.
Always remember to compare annual percentage rates (APRs) when you consider a refinance. Your APR includes both your base interest rate and any additional fees you must pay. The bigger the difference between your base rate and your APR, the more you’ll pay in closing costs when you finalize your refinance.
Change Your Term
You may also want to refinance your loan term. For example, a 30-year mortgage term means that you must make monthly payments for 30 years until your loan matures. A refinance can allow you to make your loan’s term longer or shorter, depending on your needs.
- Refinance to a longer term: You might want to refinance to a longer term if you’re having trouble keeping up with your payments. Going from a shorter term to a longer term gives you more time to pay back your loan and also lowers your monthly payment. However, a longer term also means you’ll pay more in interest over time.
- Refinance to a shorter term: You can also refinance to a shorter loan term to pay your loan off faster. When you take a shorter term, your monthly payment increases – but you save money on interest by paying off your loan faster. This can be a good option if you earn significantly more money now than you did when you first got your loan. Do the math and make sure you’ll be able to make your payments before you opt for a shorter loan term.
A mortgage loan is one of the most affordable ways to borrow money. The average credit card has an interest rate of 17.78% and the average 15-year mortgage has an interest rate of 3.5%. This means that if you have a significant amount of high-interest debt, you can save money when you consolidate what you owe with a cash-out refinance.
A cash-out refinance allows you to take money out of the equity you’ve built in your home. Every time you make a payment on your mortgage loan, you build equity. Equity is the percentage of your home that you own. When you pay off your loan, you have 100% equity in your property.
You take on a loan that’s worth more than what you currently owe with a cash-out refinance. In exchange, your lender gives you cash. Many homeowners who take cash-out refinances use that cash to pay off their debts. A cash-out refinance may or may not change your loan’s term, interest rate or payment.
Here’s a quick example. Let’s say you have a home worth $150,000 and you’ve paid off $50,000. You still owe $100,000 on your home and you have $50,000 worth of equity in your property. Let’s also say that you have $15,000 worth of credit card debt you need to pay off.
You would accept a loan worth $115,000 from your lender. In exchange, your lender pays off your existing $100,000 loan and gives you $15,000 in cash. You use that $15,000 to clear your credit card debts and continue making monthly mortgage payments to your new lender.
Take Cash Out For Other Purposes
You don’t need to use the money from your cash-out refinance just to pay off debt. Unlike other types of loans, you can use this money for almost anything. You can boost your savings or cover the cost of a home repair. A cash-out refinance is a great way to access low-interest funds for any reason.
How Does Refinancing Work?
The first step is to see if you qualify for a refinance. You must already have a significant amount of equity in your home if you want to take a cash-out refinance. Most lenders won’t refinance 100% of your equity, so make sure you have enough equity built to cover your expenses.
You also need to consider closing costs. Just like when you bought your home, you pay closing costs to your lender when you sign on your new mortgage. You can expect your closing costs to equal about 2% to 3% of the total value of your loan. As a general rule, you need to live in your home for at least a year to gain a financial advantage through a refinance.
Next, find a lender to service your loan. You don’t need to refinance with the same company that services your current loan. Compare lenders’ current interest rates and fees, ask about availability and how long the process usually takes.
Once you choose a lender, submit an application. Applying for a mortgage refinance is very similar to applying for your first mortgage. Your lender will ask you for a few documents, including your two most recent paystubs, W-2s and bank statements. You may need to provide additional documentation if you’re self-employed.
You may have the option to lock in your interest rate once you’ve completed your application. Locking your interest rate protects you against rising rates while you finish closing on your loan.
Your lender will schedule underwriting and an appraisal after you submit your documents. During underwriting, your lender looks at all of the documents you submitted and makes sure you meet minimum loan standards.
An appraiser will visit your property and give you a rough estimate of how much it’s worth. Lenders require appraisals because they need to know that they aren’t loaning you more money than your home is worth. You may need to adjust the terms of your refinance if your appraisal comes back low.
Your lender will give you a Closing Disclosure once you’re done with underwriting and appraisals. The Closing Disclosure tells you the new terms of your loan and what you must pay in closing costs. Acknowledge that you’ve read the disclosure and your lender will schedule your closing.
At closing, you’ll sign off on your new loan. Bring a valid form of photo identification, a cashier’s check for your closing costs (if you’re not rolling them into your loan amount) and your Closing Disclosure. Sign off on your new loan and begin making payments toward your new mortgage on schedule.
Keep in mind that if you get a cash-out refinance, you won’t receive funds at closing. Your lender must give you 3 business days after closing to cancel your transaction. Your loan isn’t technically closed until this window passes. Most borrowers receive their funds within 3 to 5 days after closing.
How Much Does It Cost To Refinance Your Mortgage?
Your Closing Disclosure tells you exactly what you need to pay at closing. Here are a few of the closing costs you might see when you refinance:
- Application fee: Some lenders charge an application fee due when you apply for your refinance. You must pay your application fee even if the lender rejects your refinance request.
- Appraisal fee: Most lenders require appraisals before refinancing. Most appraisers charge $300 – $500 for their services.
- Attorney fees: In some states, an attorney must review and file paperwork for your loan. Attorney fees can vary widely by state.
- Title search and insurance: Your lender may require another title search when you refinance your loan.
Expect to pay 2% – 3% of your loan balance in closing costs. You may be able to roll your closing costs into your loan balance, depending on your lender’s requirements.
Should You Refinance Your Mortgage?
If any of the following apply to you, you may want to consider refinancing your mortgage loan.
You’re Having Trouble Making Your Payments
Your monthly payments go down when you refinance to a longer term. A refinance can potentially save you from foreclosure if you’re having trouble making your mortgage payments.
You Can Get A Lower Rate
You’ll save money by paying less in interest if interest rates are lower now than when you first got your loan. You may also be able to get a lower interest rate if your credit score is higher now than when you got your loan.
You Want To Get Rid Of PMI
Private mortgage insurance (PMI) protects your lender in the event that you default on your loan. Most lenders require PMI if you have less than 20% down on your loan at closing. You may refinance and cancel your PMI if you now own more than 20% equity in your home.
It’s a little different with FHA loans, which are backed by the Federal Housing Administration and protect your lender if you happen to default on your loan. You must pay for mortgage insurance throughout the life of your FHA loan if you had a down payment of less than 10%. Many people who buy a home with an FHA loan refinance to a conventional loan after they reach 20% equity and remove their monthly insurance requirement.
You Have A Large Expense To Cover
A cash-out refinance can give you access to a low-interest loan. A cash-out refinance offers an option if you have a major expense coming up or you need to pad your savings.
A refinance means that you pay off your original mortgage and take on a new loan. You can refinance to change your interest rate or mortgage term, consolidate debt or take cash out of your equity.
Applying for a refinance is similar to the home purchase process. You submit an application to your lender, undergo an appraisal and underwriting and attend a closing meeting.
You pay closing costs when you close on a refinance – just like when you signed on your original loan. You might see appraisal fees, attorney fees and title insurance fees all rolled up into closing costs.
Generally, you’ll pay 2% – 3% of your refinance’s value in closing costs. A refinance can be a good option if you’re having trouble making your payments, if you need cash or if you want to remove PMI.
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