Among the many real estate terms that you might not be familiar with is “refinancing.” What does it mean to refinance your home, and importantly, is it the right step for you? Let’s explore.
What it Means to Refinance Your Home
In a nutshell, when you refinance your home, you trade in your old mortgage for a new one. Homeowners do this because the newer mortgage has more favorable terms. When you refinance your mortgage, the lender is going to pay off the old balance with the new mortgage.
Why Refinance a Mortgage?
There are a number of reasons why a homeowner might decide to refinance their home:
- The new mortgage might have a lower interest rate, saving the owner money over time.
- The term of the new mortgage might be shorter.
- The homeowner might want to switch to a different type of mortgage. For instance, you might refinance from a fixed-rate mortgage to an adjustable-rate mortgage (or the other way around).
- The owner might want to dip into their equity. People will sometimes do this when they run into a financial emergency.
- They want to leverage a cash-out refinance loan. This means that they take out a new mortgage that’s larger than what they owe on the house, and use the leftover money for something else.
What are the Benefits of Refinancing a Home?
We touched on some of these already, but let’s revisit them anyway.
1. You Could Obtain a Lower Interest Rate
This is one of the more common benefits of refinancing. A lower interest rate means lower monthly payments, and it could also mean paying off your mortgage faster. Over time, this can equate to thousands of dollars in savings.
2. You Can Secure a Fixed Interest Rate
Homeowners who initially took out a loan as an adjustable-rate mortgage will often refinance and opt for a fixed interest rate. This can offer added stability and, once again, significant savings.
3. Pay Off Your Loan Faster
Depending on the age of your loan, if you can secure reduced interest rates, you might be able to refinance to a shorter-term loan and not even see a huge change in your monthly payments. For instance, borrowers will sometimes refi from a 30-year loan to a 20-year one.
4. Use Your Equity for Another Expense
While this isn’t something to take lightly, refinancing can offer you liquid cash when you need it. With the mortgage payments you’ve made thus far, and any equity you’ve built as a result of your home growing in value, you could opt for a cash-out refinance to tap into that equity.
Similarly, there are a number of reasons why you should not consider refinancing your mortgage:
- If you want to switch to a longer-term loan, note that this isn’t simply about giving yourself more time to pay off the balance. This also means that you’re going to pay more in interest.
- If you’re doing this solely to consolidate debt, choose wisely. Let’s say you choose a cash-out refinance to pay off credit card debt, but then you’re unable to pay for your mortgage. The penalty for missed credit card payments is far less dire than missing your mortgage payments.
- If the goal is to save for a new home, refinancing might not be the best option. Depending on how long it takes you to recoup the cost of the refi, you might not end up even saving any money.
Essentially, there are a number of logical benefits when it comes to refinancing your home, as long as you plan accordingly and consider all the details. It then comes down to whether or not this is the right fit for you. Let’s get to that next.
Should I Refinance My Home?
Now that you know what it means to refinance a home, plus some of the benefits of refinancing, you might be wondering, “Is this the right choice for me?” There are a lot of variables to consider:
- What mortgage(s) is available to you? What are the rates and the lengths of the terms?
- How much equity do you have in your home? The more you have, the better.
- Do you have a good credit score? The higher your credit score, the easier it’s going to be to obtain lower interest rates.
- What’s your debt-to-income ratio? This refers to how much money you owe compared to how much you earn.
- What additional expenses can you expect if you decide to refi? Think of things like closing costs and taxes.
How Do You Refinance Your Mortgage?
It can be a complex process, but here are the general guidelines we recommend you follow.
Step 1: Consider Your Current Standing and Your Options
What’s your credit score like right now? What types of loans are you considering, and what interest rates might you get based on your credit score?
Step 2: Request Quotes from Difference Lenders
Don’t go with the first offer, because you want to have something to compare it to. See who’s able to give you the best rate.
Step 3: Submit Your New Mortgage Application
At this point, your lender will begin work on underwriting your new loan. You’ll have to verify your financial details, as well as get an appraisal. This will determine the value of your home.
Once your application is accepted and the process moves forward, you’ll eventually have a three-day waiting period where you can back out or reconsider the details of your refi. However, if everything is looking good to you, then you’re set to move forward!
While the steps involved in refinancing your mortgage can seem overwhelming, two important tips will help you stay on track: (1) Do your due diligence, and (2) see what different lenders can offer you.