If you are thinking about refinancing your own home, it can be hard to know exactly where to start. Don't worry. We've gathered everything you need to know in one place, so you don't have to begin this journey on your own. Empower yourself today with this essential knowledge so you can make the right financial choices for you and your family.
What Is Mortgage Refinancing?
Whether you heard about it from your friend or saw something scrolling online, refinancing your home has become increasingly popular for millions of Americans. As home prices have gone up, people's home equity has also risen.
This equity (your home’s current value minus what is still owed) has made refinancing attractive to many homeowners for a variety of reasons. When refinancing, you replace an existing mortgage with a new one. Your new monthly payments, interest rate, and other mortgage specifics will depend on many factors, including the current value of your home, your financial circumstances and credit score, and your particular lender.
How Does Mortgage Refinancing Work?
Refinancing pays off one debt while simultaneously creating another. In the case of home refinancing, you would take out a new mortgage to pay off the original. The terms, length, and amount you owe on your new home loan may be different, but you will still be required to make monthly payments.
Why Is Refinancing so Popular?
There are several reasons people choose to refinance their home. Whether they want to extend or shorten their payments, use the equity for home improvements or bill consolidation, or even lower their interest rates, each individual's reasons can vary. Below we’ll discuss some of the most common reasons homeowners refinance and how they may apply to you.
Reduce Your Interest Rates
Over a 15- or 30-year period, interest rates can change often and they can change drastically. Thanks to refinancing, you don’t have to be stuck with the same interest rate for the full life of your mortgage. With rates at historical lows, more and more homeowners are taking advantage of refinancing. Securing a lower interest rate can help you save a significant amount of money over the lifetime of your loan. Lower interest rates may help lower your monthly payments, too.
Take Cash Out of Your Home
If you owe less money than your home is worth, then you may be eligible for a cash-out refi. This type of loan allows you to borrow against your equity, and then use that extra cash for home repairs, major expenses, or other financial needs. You can even use it to consolidate debt into one easy monthly payment.
Extend or Shorten Your Loan Terms
Often, people are looking to change the length of their mortgage when they refinance. There are pros and cons to whatever repayment schedule you choose. Shortening your terms can help you lower interest rates and help you pay less overall. Meanwhile extending payments may help reduce monthly payments—putting more money in your pocket each month.
Lower Your Monthly Payments
In addition to changing your loan terms, there are other ways in which refinancing may lower your monthly payments. You may enjoy a lower interest rate or you could potentially eliminate a monthly insurance installment. Either way, exactly how much you can save each month by refinancing will vary according to your situation. However, your lender should be able to give you the particulars before you choose whether or not refinancing would be right for you.
Avoid Looming Balloon Payments
With a balloon mortgage, you are paying lower interest rates and a smaller monthly payment. However, at the end of the loan term—which is typically five to seven years—you are required to repay the remaining balance in one lump sum. If you have a balloon mortgage that is coming to a close and you are unable to make the final payment, then refinancing could help. Refinancing to a conventional fixed rate mortgage can lengthen the loan term and eliminate the need to make a large balloon payment and could help you and your family keep your home.
Eliminate Private Mortgage Insurance (PMI)
PMI could be adding hundreds of dollars to your mortgage payment every month. If you owe less than 80% of your home's value, then refinancing could help you eliminate your PMI payments.
Eliminate Your Mortgage Insurance Premiums (MIP)
MIP is very similar to PMI and protects lenders investments, but MIP only applies to FHA loans. FHA loans issued before June 2013 are eligible for MIP cancelation after five years for homeowners with 22% equity or more. However, FHA loans obtained after June 2013 must refinance into a conventional loan to get rid of their MIP payments—regardless of their current home equity.
Change Your Loan Type
From VA loans to adjustable-rate mortgages (ARM), there are a variety of loan options to choose from when purchasing a home. However, people's needs and financial circumstances often change. The mortgage that made sense five or ten years ago might not make sense today. If you are looking to change the type of mortgage you have on your home, refinancing is a great option.
Is Now the Right Time to Refinance?
So far in 2019 Americans have seen record-high home prices, along with record-low interest rates. Historically, refinancing makes sense when home prices are high, and interest rates are low. If you could lower your interest rate by 1% or more, then refinancing could make a lot of financial sense right now.
Additionally, it may be unlikely that interest rates will be significantly lower in the near future.
Average Mortgage Rates over the Last 10 Years
Since reaching a high of more than 18% in 1981, mortgage rates have been on a steady decline. Over the last 10 years, average rates have remained just at or below 5%. Below are the average interest rates on 30-year fixed-rate mortgages over the last 10 years.
Should We Expect Rates to Change?
Unfortunately, predicting interest rates is not an exact science. In part, this is because many economic factors can influence rates, including tariffs, trade wars, and consumer confidence. Even with some experts predicting lower rates for the second half of 2019 and into 2020, nothing is for certain. Because interest rates fluctuate, it is always best to check with your lender for the most up-to-date rates.
Should You Wait for Lower Interest Rates?
While rates may continue to decrease, nothing is 100% certain. If your interest rate is your primary concern, then there are more predictable ways to lower it. Buying points allows you to pay additional fees to your lender to obtain a lower interest rate. These fees can vary but are typically around 1% of your total loan amount, and will need to be made when you refinance.
How to Know if Refinancing Is Right for You
While refinancing offers many benefits, it's not for everyone. Whether you qualify to refinance your home will depend on several financial factors, including your credit score and home equity. Lenders will want to review your creditworthiness, same as when you first purchased your home. So, make sure your finances are in order before applying. Below are some helpful questions to ask before you refinance your home.
How Much Equity Do You Have in Your Home?
You can calculate the equity in your home by subtracting your current mortgage balance from a current market appraisal value of your home. The difference is your equity. Refinancing requires a minimum of 5% equity to work, but something closer to 20% is ideal. The more equity you have, the easier refinancing will be.
What’s Your Debt to Income Ratio?
Lenders want to know if you can afford to make the new monthly payments after you refinance. They will look at your debt to income ratio, and most will not approve a monthly payment that is more than 30% of your income. Lenders want to see your overall debt to income ratio below 43%, including student loans, car payments, child support, and other financial obligations.
Do You Have a Second Mortgage or Lien on Your Home?
Other loans and liens could create a challenge for refinancing. If you want to refinance your home, then consider resolving all liens and paying off any second mortgages first. Luckily, these exceptions do not make refinancing impossible, and in some cases, refinancing can help you consolidate two mortgages into one.
Do You Owe More than Your Home Is Worth?
In most cases, owing more than the current value of your home will make it challenging to refinance. However, there are some exceptions, including federal programs designed to help people refinance. You can check with your lender to see if you qualify for these programs.
Is Refinancing Your Home Really Worth It?
Interest rates and other factors have made this the perfect time for millions of Americans to refinance their homes. But is now the right time for you? Everyone's situation is unique, but there are several questions you may want to consider before you refinance.
Can You Afford to Refinance Your Home?
Refinancing can drastically improve your overall financial situation. Closing costs for a refinanced home loan will cost you between 2-4% of the total loan amount. If you do not have that kind of cash don't get discouraged. It is possible to roll these extra costs into your loan, but you will end up paying interest on the amount—increasing your overall costs. Additional costs you may need to consider when refinancing include points, taxes, and other lender fees.
Will You Get Stuck Paying More When You Refinance?
Before you refinance, you should consider the amount of interest and principal you have already paid into your home. While refinancing can significantly lower your monthly payment, you may end up paying far more in the long run, depending on the type of loan and terms you choose. Switching to a shorter-term loan, such as a 15-year fixed, could help you pay less overall, but will also mean higher monthly payments. Work closely with your lender to identify terms that make sense for your financial goals.
Are You Planning to Move Soon?
If you and your family are not planning on staying put for a while, then refinancing might not work. There is usually a break-even point for refinancing your home. This is the amount of time it will take to recoup your closing costs. For example, if your closing costs were $2,500, but you saved $100 a month, then it would take you 25 months, or about two years to recoup those costs. Make sure you will be sticking around long enough in your home to make refinancing worth it.
Getting Started with Refinancing Your Mortgage
After carefully considering your options, if you have decided that you are ready to refinance your home, then we have a plan to help get you there. Follow the steps below to refinance your home mortgage successfully.
Step 1: Define Your Goals
When you are ready to refinance, take time to write down your why. From lowering your monthly payments to getting rid of your PMI or MIP, refinancing can help you achieve a variety of financial goals. Be as specific as possible with these goals. This will help you and your lender identify a refi plan that is right for you.
Step 2: Select Your Loan
Once you know what your goals are, then it should be easy to identify the type of loan that can help get you there. Your lender will be able to give you loan options based on your specific situation, but in general, home refi loan options include:
- Rate-and-Term Refinance Loans
- Fixed-Rate Refinance Mortgage Loans
- Adjustable-Rate Refinance Mortgage Loans
- Cash-Out Refinance Loans
- Cash-In Refinance Loans
Step 3: Shop Different Lenders
Not all lenders are the same, and their fees, interest rates, and closing costs can vary. Ask your lender some questions when you apply. Make sure that in addition to a reasonable price, they can provide the expertise and service you will need to complete the process on time and within your budget.
Step 4: Lock In Your Rate
After you find the right lender, work quickly to lock in a low-interest rate. That way if rates rise between now and the time you close, you won't be stuck paying extra.
Step 5: Close Your Loan
Closing is usually the easy part. It will work very similarly to when you first purchased your home, but this time no keys are exchanged. Once you sign your papers, pay your closing costs, and receive your Closing Disclosure, you will be all set.
Step 6: Celebrate!
This is the step you have been waiting for. You finally get to sit back and enjoy the benefits of all your hard work. Refinancing is not for everyone, but when it works out, it can help bring financial success to you and your family for years to come. So go home and celebrate, you earned it!
Get the Right Deal with First Service
We know refinancing your home can be intimidating. First Service provides expert financial advice so you can always make the right choice for you and your family. For more than 40 years we have given the hard-working people of Houston a simplified financial experience, and we can do the same for you.
Schedule a free consultation today to learn what your options are and whether refinancing your mortgage can help you accomplish your financial goals.