Intro – How Does Refinancing Work – Refinancing Your Home
With mortgage rates at an all-time low, refinancing has gained popularity. But how does refinancing work in that effect?
The following questions might be ones you have found yourself asking, and hopefully the answers to them will facilitate your understanding of what refinancing your home is all about, as well as determine whether or not it’s the best financial move for you.
What is refinancing?
Refinancing your home essentially means you’re requesting a new loan; you’re basically acquiring a fresh loan by paying off your old one.
Since a new loan typically has new terms, your lender has to confirm that you meet the required criteria to refinance.
In order to do that, lenders have to gather important information as well as the necessary papers from you. Once you apply for refinance, your lender will check into the following:
- your income
- your employment history
- your credit score
- your payment history
- all your assets
- an appraisal that ascertains your home’s current value
How does refinancing work?
When you’re you are fundamentally trading in your current loan for a new one that carries a different interest rate and term, and maybe even a new balance.
If you’re looking to find out , you should note that there are two main options – two types of mortgage refinances from which to choose.
The typical “rate and term refinance” will allow you to get hold of a lower loan rate, a shorter term, or both, while your existing balance remains the same. On the other hand, the cash-out refinance gives you the opportunity to tap into your home equity.
Rate and Term Refinance: This type of mortgage refinance allows you to replace your existing home loan with a new loan that comes with a lower interest rate and/or a new mortgage term. When you open this new refinance loan, you basically pay off your current home loan, so your existing balance will be transferred to a fresh mortgage.
You’ll usually consider this type of refinance loan if your present home loan is an adjustable-rate mortgage (ARM) and your fixed period is about to expire. Refinancing your home with a “rate and term refinance” might also be ideal if there was a significant drop in mortgage rates from when you had originally taken out your home loan.
Cash-Out Refinance: When refinancing your home, if you choose to “cash out” on top of your old loan, your new loan balance will then be bigger than your initial one.
Nevertheless, bear in mind that even though you’ll be handed cash, it is not free money. As soon as you refinance, your new mortgage will be made up of your previous balance plus the cash-out total for which you applied. This typically means that your mortgage payment will be bigger.
You can elect to apply for a “cash-out refinance” either to consolidate your debt or to use the money for home improvement or potential investments. You may also use the sum to pay off your high-interest rate credit card bills.
However, you need to understand what risks are at hand if you can’t manage your monthly loan payments. What’s more, when you cash-out, you lose the home equity you’ve been saving up, as well as pile on more debt — so it is imperative you assess your situation well before you choose this path.
Why do people refinance?
People generally refinance to take advantage of a better mortgage rate, but that’s not the only reason you may decide to do so. The following are various motives behind people’s choice of refinancing their home:
- to get a lower home loan rate
- to switch from an ARM to a fixed mortgage
- to trim down their monthly loan payments
- to withdraw their home equity in the form of cash
- to consolidate other debt or mortgages
- to pay off other high-interest rate loans or credit cards
- to have someone removed from a loan
- to eliminate mortgage insurance
- to switch to another ARM when your existing one is about to adjust
- to swap loan programs
Can I refinance my mortgage?
Many homeowners find that, regrettably, they don’t qualify for a refinance. Since you’re actually required to qualify for a mortgage, it’s crucial that you make sure you have your finances in order to evade any issues that may arise in the loan process.
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Why might you be denied a refinance? The following are a number of common reasons why one may not qualify for such a loan:
- the loan amount is too big, making it hard to get a low rate or refinance
- a lack of home equity or a loan-to-value ratio (LTV) above the acceptable level
- insufficient income
- a lack of steady employment
- a very low credit score (one below 620 is normally considered as “subprime” and, especially if there’s a combination of that and high LTVs, qualification will be difficult)
- a lack of assets/asset documentation
- the home was listed for sale before one chose to refinance
Nevertheless, take heart. If you’re underwater, the Home Affordable Refinance Program 2.0 – better known as HARP 2.0 – can help you fulfill your wish of refinancing your home to a mortgage with a lower monthly payment.
Millions of homeowners have already taken advantage of HARP, and its successor, HARP 2.0, is even more appealing as it comes with looser restrictions with respect to income verification and no LTV limit – you can refinance irrespective of how far your home value has fallen.
If this sounds like you, and you’ve been hoping to refinance your home, it might make sense for you to take advantage of the opportunity now, as the program ends on December 31, 2016.
Should I refinance my home?
As a general rule, if you’re able to decrease your monthly loan payment and you can counterbalance the costs incurred by refinancing, then the refinance option might be good for you. Refinancing your home might make sense for you if:
- your current loan is an ARM, and you’re refinancing into a fixed-rate mortgage
- you’re consolidating the balance of two loans into a single one
- you’re in a dire situation and have the needed equity for a cash-out
- you want to build home equity by shortening your loan term, and you’re good for the higher monthly payments
You can use a refinance calculator to check whether refinancing makes sense for your unique circumstances. You can also get quotes for real-time refinances by anonymously submitting a loan request on Zillow.
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How much does it cost to refinance?
Fees are almost always charged by lenders when you’re taking out a fresh loan. The costs of refinancing are governed by the size of the loan and the program for which you qualify. These could include:
- application charges
- appraisal fees
- origination costs
- insurance fees
- costs incurred by the title search
- legal costs
The above fees differ depending on your lender, and many of them are negotiable. It is recommended that you shop around, comparing all the related costs of your refinance. It’s also good to check whether you’ll be charged for paying off your existing mortgage.
The prepayment penalty may vary in quantity, but it might end up amounting to a couple of months’ worth of interest payments. It’s best to enquire with your lender beforehand.
Can I refinance my mortgage with no closing costs?
There will always be closing costs involved when you’re taking out a new refinance home loan. When you’re taking out a refinance mortgage, no closing costs isn’t a real option. No-cost refinancing is basically a myth owing to marketing schemes. You can achieve a so-called no-cost refinance if, in exchange for not paying closing costs, you get a higher-than-market rate.
Therefore, no, you cannot really refinance with no closing costs – at least not in the sense you’re hoping for. However, over time, your monthly savings brought on by the refinance will cover those closing costs.
Your best bet is to break even. The point of break-even of a refinance is basically when you can offset the closing costs of the new loan by your lower monthly loan payments. This way you can benefit in the long run, as the new mortgage payments will save you money every month.
Can I refinance with bad credit?
If your credit score isn’t commendable, at a good interest rate will probably be difficult – perhaps even impossible. Your credit score is used by lenders to establish the likelihood of you defaulting on payments. Your credit score can be calculated by checking the following:
- your payment history (35%)
- the amount owed (30%)
- the period of time you’ve had credit (15%)
- your new credit (10%)
- the type of credit (10%)
A perfect score is 850, and the range goes down to a “very poor” 300. Since the majority of your score is determined by your past payment history and your debt aggregate, if you have too much debt or you’ve failed to pay your bills in a timely manner, lenders will view you as “high risk.”
So, how does refinancing work for someone with poor credit? They will be charged a higher interest rate when they refinance, since the lender is undertaking more risk by loaning that person money. Thus, if you want to refinance with bad credit, you have to estimate your monthly mortgage payments and determine whether refinancing is really and truly right for you.
It might not make sense financially for you to refinance with bad credit when you take into account the fees and closing costs incurred by the new loan. However, there are still other options, like FHA loans, but you have to shop around more in order to get hold of them.
Should I refinance with my current lender?
Refinancing your home with the same bank or lender that held your old loan could be seen as the easier option, as the lender would already know your payment history and property. In that case, a new property appraisal and title search, among other requirements, might not be needed with your current lender.
However, before you elect to get hold of a new mortgage from the same lender, it’s advisable that you shop around. Your original mortgage lender might not have the best deal. So do your homework. Discover the offers of competing lenders. It will definitely be worth your while (especially if you end up saving money!).
Is refinancing necessary?
It is true that your mortgage rate might rise if you fail to refinance, but you need to factor in closing costs and fees when you’re crunching the numbers. Regardless of how much lenders seem to be eulogizing refinancing, it might not be the winning move for your particular situation.
Refinancing your home might help you stay in it for less money, but you need to be sure that it’s the right way to go – that it makes financial sense for you. Before you “reset your mortgage” or borrow more than you need, you should do the math and identify how the new mortgage will affect you.
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