Refinancing a mortgage can be a big financial decision, one that takes into consideration many factors, including interest rates, loan terms, anticipated residency in home, among other things.
To determine if a refinance is right for you, I will discuss several reasons why you might consider a refinance — as well as some reasons why you might not.
What Does it Mean to Refinance Your Mortgage?
Refinancing your mortgage is the process of taking out a new mortgage loan to replace your existing one, usually at a more favorable interest rate. It is recommended to shop around for a few lenders to see who will offer you the best interest rate. Additionally, you may have the option to choose a new loan term length.
There are many reasons to refinance a mortgage loan. Some of the most common reasons include:
- Secure a lower interest rate
- Change from an adjustable-rate mortgage to a fixed-rate mortgage
- Get rid of private mortgage insurance (PMI)
- Consolidate high-interest debt
- Obtain a shorter loan term so you can pay off the home faster
- Obtain a longer loan term to enjoy lower monthly payments
Considerations for Refinancing Your Mortgage
Before committing to a refinance, you should make sure the refinance will truly be financially beneficial. Compare your current interest rate and loan terms to the proposed refinanced mortgage loan. Make sure you understand how much your new monthly payment will be and how long it will take you to pay off the new mortgage.
One important note: you will likely be required to pay loan origination fees and closing costs again when you refinance, so you should consider these amounts in your calculations.
While there’s no concrete number to base your decision on, a general rule of thumb is to refinance only if the new interest rate will be at least 1% less than your current mortgage rate, in order to reap any savings benefits.
Reasons a Mortgage Refinance Might Make Sense
AAs I stated above, there are various reasons why you might want to refinance your mortgage loan. Below, I’ll explain six of the most common reasons people choose to refinance — and how they can benefit you.
Lower Your Monthly Payments
A refinance can potentially lower your monthly payments. For example, if your current mortgage rate is 1% (or more) higher than the average interest rates at the time you refinance, you’ll likely have decently lower monthly payments. Alternatively, if you’ve improved your credit score, you may be able to secure better terms.
Furthermore, if you originally financed with a 15-year loan and want to lower your payment, you may be able to refinance into a 20- or 30-year loan to get those payments down. This can allow you to redirect your money toward other financial goals — just remember that you’ll be making those payments for a longer period of time (and you’ll pay more in interest over the life of the loan as well).
Secure a Fixed-Rate Loan
If you’re currently in an adjustable-rate mortgage, you know that your interest rate can change after the fixed-rate period expires. If you’re past that date or quickly approaching it, you may want to lock in a fixed rate now before interest rates rise.
A fixed-rate mortgage makes it easier to plan for your payments when you know what the principle and interest payments will be ahead of time. This makes it easier for budgeting and affordability purposes.
Obtain Shorter Loan Terms
You can also refinance to reduce the length of your loan. If you want to pay off your loan faster and are comfortable with potentially higher monthly payments, you can refinance to secure a shorter loan term. Although your monthly payments may be higher, a shorter loan term allows you to build equity faster and pay less interest overall.
Take Advantage of Home Equity
Another option is a cash-out refinance, which means you refinance to cash out part of the equity you’ve built in your home. You can use that money for a variety of purposes.
For example, many people use cash-out refinancing to pay off and consolidate other higher-interest debt, such as credit card bills or student loans. Others use the equity to make home improvements or upgrades.
Eliminate Private Mortgage Insurance
If your down payment was less than 20% of the purchase price when you bought the home, then you most likely had to get private mortgage insurance (PMI). Once you have more than 20% equity in your home — or an 80 % loan-to-value ratio (LTV) — you can request that your PMI premium be removed from your payment.
Alternatively, if your home has gone up significantly in value, your LTV may have gone up as well. If your home appraises at a high enough value, you can refinance your loan to show that what you owe is now 80% or less of the home’s actual value.
Update Mortgage Account Holders
Sometimes, life changes. Maybe you got divorced. Maybe you had a cosigner on the original mortgage that you no longer need. Or maybe someone who purchased the home with you wants out. Either way, refinancing is the only way to change whose name is on the mortgage.
Reason a Mortgage Refinance May Not Make Sense
Of course, there will be instances when it doesn’t make sense to refinance. For example, if interest rates are higher than the rate you currently have, it generally won’t make financial sense for most people to refinance. You’ll want to make sure you carefully consider any other possible drawbacks of refinancing, such as the ones previously mentioned, before you make a decision.
You Don’t Have the Required Savings
Refinancing comes with a cost. Just as with your original mortgage loan, you’re generally required to pay for closing costs on the new loan, which can include:
- Application fees
- Loan fees
- Origination fee
- Credit report fee
- Tax service fee
- Underwriting fee
- Document preparation fee
- Wire transfer fee
- Office administration fee
- Home appraisal cost
- Title fee
- Mortgage recording fees
- Interest rate points
Your closing costs can end up being around 2-5% of your loan amount. You’ll need to have money saved up to handle those expenses. There are some options to refinance without paying closing costs, such as rolling your closing costs into your new loan amount, but you’ll want to consider the pros and cons of this option before ultimately making a decision.
The Long-Term Costs Can Be Higher
Get ready to crunch the numbers! As stated above, you can save money by refinancing if you secure a lower interest rate or drop off PMI. But if you’re already halfway through a 30-year loan, it probably doesn’t make sense to refinance just for lower monthly payments. There are exceptions to this, so you should discuss your options with a financial advisor or lender if you have good reasons for wanting to refinance.
You’re Starting Over With a New Loan Term
Finally, when you refinance your home, you restart the loan process. That means starting an entirely new term. If you were 10 years into a 30-year mortgage, you will now be 0 years into your new mortgage. Depending on the new loan term, this can add years to your repayment.
How to Refinance Your Mortgage Loan
If you’ve determined that it makes sense for you to refinance your home, you’ll need to go through the following steps:
- Select a lender and submit a loan application.
- Go through the underwriting process.
- Get a home appraisal.
- Complete the closing process.
Select a Lender and Submit a Loan Application
The application process for a refinance is almost exactly the same as when you applied for your original mortgage. Your lender will ask for updated documents to verify your financial situation, such as tax returns, W-2s, bank statements, and pay stubs – they should provide you the required documentation ahead of time, so that you’ll have ample time to prepare.
Go Through the Underwriting Process
You don’t have many responsibilities during the underwriting process — this all happens at the lender’s office! Of course, if they need more information or documentation, you’ll want to make sure you’re ready to respond promptly to keep the process moving.
Get a Home Appraisal
No matter how long it’s been since you bought your home, you’ll need to get an appraisal done for a refinance. To improve your chances of getting the home appraised at or above the amount you need for the refinance loan, make sure your home looks its best. Make any necessary repairs, ensure it’s in a clean state, and make a list of any improvements you’ve made to share with the appraiser.
If the home ultimately doesn’t appraise at the amount you were hoping for, you may be able to decrease the loan amount or do a cash-in refinance, which means you’ll have to bring cash to the table to cover the amount needed to get the terms of your refinance.
Complete the Closing Process
Once your appraisal is finished, it’s time to close! Closing on a refinance is typically faster and easier than closing on a new home loan. A representative from the lender or title company will go over the loan details with you as you sign your new loan documents. You’ll also pay any closing costs (that won’t rolled into your new loan).
Refinance Your Mortgage with Lafayette Federal
Choosing a lender to refinance your mortgage loan is easy as 1-2-3 when you’re a member of Lafayette Federal! We offer member-exclusive benefits, including: nationwide financing, competitive rates, rate discounts that save you money, up to 100% financing options, and loans up to $3,000,000.
We also provide members with a 30-Day Close Guarantee, which provides you with $250 per day (up to $2,000) if closing goes beyond 30 days.
At Lafayette Federal, we’ll work with you to figure out if a refinance is the right choice for your situation. Get started today.