Regardless of the economic climate, it can be challenging to make payments on your mortgage, especially if you have high-interest rates.
If you find yourself in such a situation, you might ask yourself, “Should I refinance my mortgage?.”
When you get your mortgage refinanced, you’re essentially replacing your current home loan with a new one. In order to buy your home, you probably had to get a mortgage, and the money went to your home’s seller.
If you refinance and get a new mortgage, the money will pay off the rest of the balance on your current loan instead.
To get approved for a mortgage refinance, you will need to meet the lender’s requirements, similarly to your original mortgage. You will need to apply, go through the underwriting process, and go to closing.
In this article, we will explore some of the most important things to consider when making this decision.
Advantages of Refinancing
The main reason people choose to refinance their mortgage is to get lower interest rates. As they advance through their careers and increase their income, as long as they pay their bills on time, they can increase their credit score and get more favorable refinancer loans.
When it comes to mortgages, even a slightly better rate can save you hundreds of dollars per year.
Another way to reduce monthly payments is to extend the loan term. Let’s say you got a mortgage for 30 years. After eight years, you refinance your mortgage for another 30 years.
You will have lower monthly payments because you had already paid part of the initial loan, and you’re also extending this smaller amount for a longer time-frame.
The disadvantage is that this means you will pay more interest in the long-run.
Another reason why people refinance their mortgage is so they can tap into home equity and obtain funds for large purchases, make renovations or pay off another loan on more favorable terms.
If you borrow more than you still owe on your current mortgage, the lender will give you the difference. First, they will have your home appraised, and based on that, they will decide how much they are willing to loan you.
This process is called a cash-out refinance, and many people use it to make improvements on their home and increase its value, thus being able to secure significant home equity lines of credit.
Other people refinance their mortgage because their income has increased, and they want to pay it off faster.
Therefore they’ll switch from a 30-year mortgage to 15 years. Even though the monthly payment will usually be higher, they’ll most likely have better credit score so they’ll get better rates and since they’ll be paying off the loan in half the time, they can pay less interest over the life of the loan.
Lastly, some people do it so they can switch from an adjustable-rate loan to a fixed-rate loan because they prefer the financial stability that comes with steady payments.
Risks of Refinancing
One of the biggest risks associated with refinancing your mortgage comes from penalties. Many mortgage agreements have a provision that allows the lender to charge you a fee for paying your mortgage ahead of time which can amount to thousands of dollars.
In some cases, this prepayment penalty will be offered in return for slightly lower rates so that the lender can be sure they will recover their costs even if the borrowers sells or refinances. Usually, these penalty fees expire after a few years.
If you’re considering refinancing our mortgage, it’s best to check what the penalty is and if the refinancing is still worthwhile.
There are some other fees to be aware of when refinancing such as application fees, title search, title insurance and attorney fees.
Usually to company or attorney that does the closing will charge your lender a set of fees which, in turn, your lender will transfer to you, the borrower. You will also need an attorney that can help you get the best deal possible and handle the paperwork.
Common Mistakes People Make When Refinancing
It’s surprising how many people go straight to their regular bank or original lender when they need to refinance their mortgage.
Although sometimes it makes sense to refinance with the original lender because it may require less paperwork and they could actually offer you a good deal, it’s still better to shop around and compare.
Even a difference of 1% can mean thousands of dollars over the life of the loan.
Since mortgage pricing can be rather complicated, you need to take a close look at the terms, fees, and rates offered by the different lenders.
Most people get too fixated on the interest rate, and they don’t realize how many factors go into the actual cost. A low refinance rate can sometimes disguise unusually high rates making the loan less favorable than one with a higher rate.
You’ll also want to calculate your break-even point which means after how long will your recover the closing costs through the money you’re saving on interest.
It’s likewise a mistake to refinance too often and that’s also because of the closing costs. Even if interest rates go down because of economic changes, you need to sit down, do the math and figure out if it’s a good time for you.
Otherwise, you risk piling up closing costs and negating the main benefits of refinancing.
And finally, we have to discuss home equity. As we mentioned earlier, many homeowners use a mortgage refinance to take out a loan with lower interest rates against their home equity for remodeling projects, investments or major purchases such as a car.
This is usually not a problem because remodeling projects increase the value of their home, and even if the money is used for other purposes, the low rates make this a sensible way to borrow money.
The problems start when you take out too much equity and leave yourself without a healthy cushion.
If housing prices fall or you increase your monthly payments too much, you’ll have few options in case of financial problems caused by loss of income or an illness.