Mortgage refinancing offers significant benefits to homeowners. It gives them the ability to consolidate their debts, pay off their mortgage sooner, and save money with lower interest rates.
But refinancing at the wrong time or for the wrong reasons can cause problems down the road. In this guide, we’ll answer all your questions from “What is a mortgage?” to “How does refinancing work?”
Just keep reading.
What Is a Mortgage?
A mortgage is a loan used to purchase real estate including homes and commercial properties. Mortgage loans are given by banks and credit unions and web-based lending companies.
You can adjust your mortgage to fit your budget and lifestyle. As a borrower, you can choose the term (length in years) of your mortgage.
While also selecting the type of interest rate. Be it a fixed rate where the monthly payment and interest rate don’t change throughout the term.
Or it can be an adjustable rate, also known as a hybrid. These rates change annually after having been fixed for a period of time. For example, if you have a 5/1 loan, you will have a fixed rate for 5 years before it adjusts annually.
What Does It Mean to Refinance?
Because homeowner’s needs change over time, refinancing your mortgage is usually always an option. Refinancing means to change the terms of your mortgage loan. This essentially replaces your current loan with a new one.
When refinancing, you don’t have to use the same lender you worked with the first time around. This process also requires a lot less time and paperwork than an initial purchase mortgage loan.
The reasons you might refinance vary. Refinancing can help you decrease your monthly payments, pay your home off quicker or use equity for major purchases.
There are three main ways to refinance a mortgage. You can use rate and term, cash-out, or cash-in.
The rates and other terms differ between these options.
With a cash-out refinance, you will refinance your mortgage for an amount higher than what you currently owe. The difference is then paid out to you in cash.
You will usually need to have about 20% equity in your home to be approved. For instance, let’s say you’ve been making timely payments on your mortgage for a few years. Over this time, the value of your home has increased.
Now, the balance you owe is $90,000 and the house is now worth $280,000. You did some research and learned that you can now get a lower mortgage rate. You refinance and use the cash to pay off bills or remodel your home.
Cash-in refinance is the exact opposite of a cash-out refinance. If you choose this refinancing option, you’re essentially using your funds to lower your mortgage balance.
Before opting for a cash-in refinance, there are things you should take into consideration. For instance, will your money earn more interest in an investment or retirement account?
If so, using it to lower your mortgage balance may not be as great of an idea as you think. Review your finance and investment options before looking into a cash-in refinance.
Rate and Term Refinance
With a rate and term refinance, you can change the interest and or the term of your mortgage. With this method of refinancing, you won’t have to pay additional money out of pocket.
The primary benefits of this kind of refinance are securing lower interest rates and more flexible mortgage terms. This can lower your monthly payments, although it won’t change your principal balance.
Maybe you’re in the middle of paying off your 30-year mortgage when you notice a decrease in interest rates. With the rate and term refinance, you can take advantage of the lower interest rates for the remaining 15 years of your term.
While your payments will be higher than if you had started a new 30-year term, they’ll be lower than what you’d initially agreed on. Your house will normally be paid off sooner with a rate and term refinance.
Should You Refinance?
How do you know if this is a step you should take? Every homeowner’s situation is different. However, we’ve explained a couple of common scenarios below.
1. How long will it take the mortgage to start paying for itself?
Divide the amount you’ll spend in closing costs by the amount of money you’ll be saving every month.
If you’re spending $3,000 in closing costs and saving $100 every month, this will mean it’ll take a total of 30 months for the refinance to pay for itself. If you don’t plan on being in your house for the amount of time you calculated, refinancing isn’t worth it.
2. Understand your new and old terms.
If you choose to start a new 30-year term when you refinance, you can end up spending more money over time. In this case, your monthly payments are smaller, but your balance isn’t. If this is your situation, you shouldn’t refinance.
You can insert the specifics of your loan by using this tool. Before you refinance, use this to compare multiple scenarios to see what will work best for you.
3. Know Your Credit
Also, be sure to take a look at your credit score before you refinance. A good score can save you money whether you’re refinancing or applying for a new mortgage.
The best refinancing options will reduce your monthly payments, shorten the term of your loan, or help you quickly build equity. This process isn’t for the impatient.
Although less paperwork will be involved than when you initially bought your home, there will still be a lot of it. Additionally, it will take a bit of time before you begin to see the impact of the money you’ll save and other benefits of refinancing.
We know that making decisions like these aren’t to be taken lightly. This is why we do our best to serve our customer base in Kansas.
If “What is a Mortgage Refinance?” didn’t answer all your questions, please don’t hesitate to contact us.