Do you have a loan that is no longer working for you? Have you recently improved your credit score and thinking that you can get better loan rates? If so, refinancing your mortgage should be your next financial idea. Simply put, mortgage refinance involves taking a new loan to pay off an initial mortgage loan. However, in what situations does this make sense?
With the current sprawling economic situation, homeowners with home mortgages may find it difficult to make timely payments. From the high-interest rates to an unstable economy, making payments becomes tougher than expected. If you find yourself in this situation, you should consider refinancing. The only danger with refinancing is ignorance.
Without proper knowledge, refinancing can lead to significant negative effects. You may end up increasing interest rates than lowering them. That said, the guide below details the fine print of mortgage refinance you ought to know.
What are the Reasons to Refinance Mortgage?
There are both obvious and less obvious reasons to secure mortgage refinance. The reasons include;
Refinancing to secure a low-interest rate
Probably the most obvious reason to refinance is to enjoy low-interest rates on your existing loan. As a rule of thumb, refinancing is beneficial if you can reduce the interest rate by at least 2%. Nevertheless, even 1% is enough incentive to consider refinancing. Reducing the interest rates will not only help in saving money but also decreases the monthly payments. For instance, an initial mortgage loan of $100,000 for 30 years and a 9% interest rate attracts $804.62 interest payment. Similarly, the same mortgage loan at 4.5% interests reduces the payments to $506.69.
Refinancing to convert adjustable-rate or fixed-rate mortgage
An adjustable-rate mortgage often starts with low rates compared to fixed-rate mortgages. However, subsequent adjustments may lead to high rates than those of fixed-rate mortgages. If such occurs, you can consider mortgage refinance to convert your ARM to a fixed-rate mortgage. This also eliminates worries of future interest rate hikes.
On the other hand, converting from a fixed-rate mortgage to ARM is prudent if the interest rates are falling. If the rates continue dropping, periodic adjustments on ARM results in decreased rates, and small monthly payments. In such situations, it is a wise financial decision to refinance from fixed to an adjustable-rate mortgage.
Refinancing to lengthen the loan term
Even with constant interest rates, homeowners can lower their monthly payments by refinancing. How is this so? Homeowners can take a new loan with a longer-term. For instance, say you took a 30-year loan of $250,000. After ten years, the loan balance could be down to $200,000. You can take a new 30-year loan for the remaining balance, which lowers the monthly payments. However, you will have to endure the additional ten years onto the loan. Extending the loan term of mortgage loans makes perfect sense if you have trouble submitting your payments. Note that by stretching the mortgage, you will pay more interest in the end.
Refinancing to consolidate debt or tap equity
Whereas all the above reasons for refinancing are financially sound, mortgage refinance can be a source of never-ending debt. Homeowners can access their home’s equity for major expenses. Such expenses include children’s college education or home remodeling. Such owners may justify that remodeling adds more value to the house. Besides, mortgage loans have low interests than other lenders.
Another fraction of homeowners refinance to consolidate their debts. At a glance, substituting high-interest debts with low-interest mortgage loans is prudent. However, refinancing does not help with financial discipline. You should consider this if you are sure you can resist spending temptations once refinancing leaves you debt-free.
The majority of those who once generated high-interest debts on cars, credit cards, and more will most likely do it again. As such, refinancing creates a cycle of wasted fees on refinancing, additional interests, and return to high-interest debts again. This results in an endless debt cycle and high chances of eventual bankruptcy.
How Does Mortgage Refinancing Work?
The process of refinancing a mortgage is quite similar to getting the first loan. You should start by shopping around for lenders, comparing various interests and terms to find a good offer. You should then compare the new rates and terms with the terms of your present loan. If you have an improved credit score, you have better chances of qualifying for favorable terms. Below is an outline of how to get a mortgage refinance.
1) Prequalification and Preapproval
Prequalification involves finding out if you can borrow. This depends on the information that you submit and is nonbinding. On the other hand, preapproval is the conditional offer from the lender. You should provide the details of your assets and income. If you later apply for the loan, the lender will re-verify this information before proceeding.
Like other loans, you begin the process by submitting an application. The application features your basic information, including;
- Name and address
- Estimated annual income
- Social security number for a credit check
- Property address
- Type of home
- The estimated value of the property
- Association dues associated with the property
- Total mortgage loan requested
Note that submitting this application will not affect your credit score. Apart from the identifying details, you should submit the following documents to the potential lender as well. These will help in verifying identity, employment status, income, and other essential information.
- W-2s for the last two years
- Pay stubs, at least for the last two months
- Most recent federal tax returns
- Recent bank and investment statements
- Earning statements from any of your businesses
- Complete list of debts – includes student loans, car loans, or credit cards.
- Canceled checks on rent or mortgage
- Social security or disability statements, if applicable
3) Loan Estimate
Once the financial details of your application verify, the lender should provide a loan estimate. This should be the best estimate of what your mortgage loan might cost. According to the law, the lender should deliver these estimates within three days after making the application.
The loan estimate outlines the interest rates, monthly payments, estimated tax and insurance fees, closing costs, and APR. You can use these details to determine if the loan is right for you or not. To make better comparisons, apply to multiple lenders at once. You can then use their loan estimates to compare various loans and select the best. Lenders should honor the specifics in the estimate for ten business days. Beyond this, the lender can change the terms due to changing market conditions.
Processing of mortgage loan occurs after you have notified the lender that you wish to proceed with the loan. Mortgage processors will order for your credit report, appraisal for the property, and report on the title attached. The processor verifies your financial details and asks for clarification if they come across anything that is questionable. Questionable details include late payments on credit reports or financial judgments. If everything is clear, the loan processor submits a report to the lender.
An appraisal estimates the value of the mortgaged property. The appraiser considers several factors before placing a value on the property. The size, location, close amenities, and physical condition are just but a few to mention. A proper appraisal is important, as it will determine the loan limit given by the lender. The lender should then provide you with a copy of the appraisal after completion. This eliminates risks of misunderstanding as you settle on the loan terms.
An underwriter determines if the loan is acceptable based on the information from the processor and appraiser. If the lender requires some additional information, the application process is suspended. The lender will ask you to provide any required documentation or details. On the other hand, if the loan is accepted, the lender approves it.
7) Closing Disclosure
As per the law, lenders should provide a closing disclosure within three days before finalizing the loan. A disclosure is a five-page form that details all the terms of the mortgage loan. It outlines the projected monthly payments, length of the loan, and closing costs. This document is like the loan estimate and meant to ensure that you are signing for what you expected. You should compare these two documents before signing to ensure that no terms have changed.
This is the final stage. You are required to sign a legally binding document that puts the application and mortgage into effect. When closing the mortgage, review all the documents, sign them, and pay for the incurred costs. You should have your identification document and proof of active homeowners’ insurance.
When doing this, take note of the closing costs. For instance, the cost of refinancing your new mortgage with the new lender could be $10,000. With such, you can have the new monthly payments just $200 lower than the initial payments. Therefore, you will have to stay in the house for at least 50 months to make this process worth it. That aside, keep an eye on pre-payment penalties and other terms that might cause problems later.
Different Types of Mortgage Refinancing
You can apply for three types of mortgage refinance loans. They include;
- Rate and term refinance loan – The goal of these loans is to change the interest rate, loan term, or both without changing the amount. It is best for those who want to reduce monthly payments or switch from ARM to fixed rates.
- Cash-out refinance loan – as the name suggests, this type involves cashing out part of your home’s equity. This results in a high loan amount. Whereas this option provides homeowners with immediate cash, it increases monthly payments and interests.
- Cash in refinance loan – this occurs when homeowners refinance their mortgage and use the money to reduce their new mortgage balance. Cash-in refinance is best if you want to keep your mortgage below a certain limit.
What Are The Costs Incurred During Refinancing?
Mortgage refinance is like any other mortgage loan with closing costs. Some of the fees you will have to pay at closing include;
Property evaluation fees
- Appraisal fee – appraisal protects the loan lender from lending more than the property is worth. A professional whom you will typically pay does this.
- Inspection – all lenders require a detailed home inspection before approving the loan. This includes septic inspection, termite inspection, water quality test, and much more. Lenders will pass the professional inspectors’ fee to you.
- Flood determination assessment – flood determination assessment is to establish if the property is within a flood zone. This might not be necessary if you refinanced with your initial lender.
Loan processing fees
- Application fees – you pay the lender for taking time to review your application.
- Credit report fees – lenders check your credit score and history to determine the loan terms. This includes data from the three major credit-reporting agencies, which are paid.
- Origination fee – this fee covers the administrative costs of the new mortgage.
- Attorney fee – the attorney reviews the terms of the mortgage agreement. This might not be necessary for all states.
- Mortgage broker fee – you will incur this if a broker helped you to find the best mortgage. The fee is included in the closing costs or rolled into the loan.
- Prepaid interest – like other loans, interest on the loan accrues once you close. As such, most lenders will require an upfront payment of the interest.
- Lender’s policy title insurance – this insurance protects the lender in case the title to the property has some legal problems.
- Owner’s policy title insurance – owner’s insurance protects the mortgage borrower from overwhelming legal costs in case of a challenge to the title.
What to do Before Refinancing Mortgage
Before applying for the mortgage refinance, it is best to ensure that you will get good rates and terms. You can do this is through;
Improving your credit score:
Like other loans, your credit history and credit score are major factors that lenders consider. They determine the amount of loan you can borrow and the interest rates. Therefore, before applying;
- Request a free copy of your credit report from all major credit reporting agencies
- Check your credit report for errors. If any, follow the specific bureau’s process to request for correction.
- Get a free credit score. You can request it from your bank or credit card issuer. Remember that the free credit score may differ from what the lender will see.
- Prequalify with multiple lenders to find out the credit score bucket that they will place you. Some lenders will consider a score of 680 as good while others have their good range starting from 700.
- Find methods of cleaning your credit to push it into the next tier.
- Do not apply for any other credit products before refinancing. Multiple inquiries for different types of credit may affect your credit score.
Establish your home’s value
You should have an idea of the value of your home before spending time and money on mortgage refinancing. For instance, for cash-out refinance, knowing the value will help you know if you can access the amount desired. That said, it is prudent to have an idea of your home’s worth before applying.
How to Choose a Mortgage Refinancing Lender
There are several mortgage lenders offering direct consumer refinancing. They include Chase, Bank of America, Quicken, and Guild. However, not all mortgage refinancing companies can suit every borrower. Selecting the right mortgage lender is a crucial financial decision. To find the best, consider the following points.
- Product offerings – this simply describes the financing options that the lender offers. The more options a lender offers, the more likely that you will find a suitable offering. For instance, if you want a 25-year refinance, find lenders who offer more than 20 and 30-year options. You should also consider a lender who offers customized adjustable-rate mortgage loans.
- Interest rates – does the lender provide competitive rates for your financial situation? In this case, shop around and compare various rates from different lenders. While comparing the interests, be keen on the APR, which represents the true annual cost of the loan.
- Closing costs – what are the closing costs of the lender compared to other lenders? You can negotiate for the fees for some closing costs. Therefore, look carefully and try to negotiate various charges. Lenders compete for business and offering a better deal can help them get clients.
- Customer satisfaction – what experience did previous customers have with the mortgage lender? Check for online reviews and consult before signing a deal with a lender.
The Bottom Line
There are no one-size-fits it all answer as to if refinancing your mortgage is a good financial decision. So to say, mortgage refinance may not be the best decision for everyone. For instance, avoid this if you have had your mortgage loan for a long time. Also, do not take the loan if the fees outweigh the savings or you plan to sell the home. However, if all the above-mentioned reasons work in your favor, you can apply for them. Interests on mortgage loans are historically low, thus suitable for those who want better interest rates.