While rising interest rates make refinancing less appealing, you should consider it if you want to access the equity in your home. If you’re thinking about refinancing, here’s how it works and what are options you will have.
What exactly is refinancing?
When you refinance your mortgage, you are replacing your existing loan with a new loan. The new loan may have different terms, such as switching from a 30-year to a 15-year term or from an adjustable rate to a fixed rate, but the most common difference is a lower interest rate. Refinancing allows you to lower your monthly payment, save money on interest over the life of your loan, pay off your mortgage faster, and access the equity in your home for any reason.
How does mortgage refinancing work?
A lender will review your finances, just as they did when you first applied for your mortgage, to assess your level of risk and determine your eligibility for the best interest rate. It’s a completely new loan, and it could be with a different lender than the one you used to purchase your home.
The repayment clock on your new loan may also be reset. Think that you’ve been paying on your current 30-year mortgage for five years. That means you have 25 years remaining on your loan. If you refinance to a new 30-year loan, you will begin again and have 30 years to repay it. If you refinance to a new 20-year loan, you will pay off your loan five years sooner. Closing costs are associated with refinancing, which can influence whether getting a new mortgage makes financial sense for you. These fees can range between 2% and 5% of the amount refinanced. Discount points, an origination fee, and an appraisal fee are all common closing costs. To determine whether you’ll stay in your home long enough to recoup the closing costs and benefit from the refinance savings, calculate the break-even point.
Mortgage Refinancing Options
Rate and term refinancing
This is a basic type of refinancing in which the loan’s interest rate, term (length of repayment), or both are changed. This can lower your monthly payment or save you money on interest. Unless you roll some closing costs into the new loan, the amount you owe will generally not change.
Refinance with cash out
When you do a cash-out refinance, you are borrowing money from your home to spend. This increases your mortgage debt but provides you with money to invest or use to fund a goal, such as a home improvement project. During a cash-out refinance, you can also secure a new term and interest rate.
Refinance for cash
A cash-in refinance involves making a lump sum payment to reduce your loan-to-value (LTV) ratio, which reduces your overall debt burden, potentially lowers your monthly payment, and may also help you qualify for a lower interest rate. Before proceeding with a cash-in refinance, consider whether paying the lump sum would deprive you of more lucrative opportunities or drain your savings unnecessarily.
A no-closing-cost refinance allows you to refinance without paying closing costs upfront; instead, those costs are rolled into the loan, resulting in a higher monthly payment and, most likely, a higher interest rate. If you intend to stay in your home for a short period of time, a no-closing-cost refinance makes the most sense.
If you are having trouble making your mortgage payments and are on the verge of foreclosure, your lender may offer you a new loan that is less than the original amount borrowed and forgive the difference. While a short refinance saves the borrower from the financial consequences of foreclosure, it comes at the expense of a credit score hit
Mortgage in reverse
If you are 62 or older, you may be eligible for a reverse mortgage, which allows you to withdraw the equity in your home and receive monthly payments from your lender. You can use these funds for retirement, medical bills, or any other purpose. You won’t have to repay the lender until you leave the house, and while the income is tax-free, interest will accrue.
Refinance debt consolidation
Debt consolidation refinances, like cash-out refinances, provide cash with one key difference: you use the cash from the equity you’ve built in your home to repay other non-mortgage debt, such as credit card debt. Your mortgage debt will rise, but because mortgage interest rates are typically lower than those for other types of debt, you may save money in the long run. Furthermore, you may be eligible for the mortgage interest deduction.
Streamline the refinance process
A streamline refinance shortens the process for borrowers by eliminating some of the typical refinance requirements, such as a credit check or appraisal. This is an option for FHA, VA, USDA, Fannie Mae, and Freddie Mac loans.
Refinancing a Mortgage
If you’re thinking about refinancing your mortgage, here’s a step-by-step guide. Before you refinance, consider how long it will take for the refinancing costs to be repaid in comparison to how long you intend to stay in the home. You’ll also want to make sure you can afford the new payment and that you still have enough equity in your home. Shop around between mortgage lenders to find the best deal.
Consider both interest rates and closing costs.
Reasons for refinancing
Refinancing requires some effort; however, is it really worth the extra paperwork and costs? There are several compelling reasons to invest time and money in a refinance:
You may be able to hold on to a lower interest rate. — The opportunity to lower your interest rate is the most compelling reason to refinance. Whether your credit has significantly improved since you first secured your mortgage or the market has changed, being able to access a lower interest rate can save you good money over the life of the loan. However, in today’s rate environment, you’re unlikely to save much unless you obtained your original mortgage at least ten years ago.
You can obtain a different type of loan. — Perhaps you want to avoid the uncertainty of an adjustable-rate mortgage by switching to a conventional loan, or you want to avoid paying FHA mortgage insurance by switching to a conventional loan. Refinancing allows you to investigate all types of home loans to find one that works best for your financial situation.
You can borrow money by using your equity. — In addition to saving money, refinancing may allow you to access more funds. Cash-out refinancing allows you to use the equity you’ve built up to borrow more money. While this increases your debt, it can help you secure funding for large expenses, such as a home improvement project or college education, at a low interest rate.
You have the option of limiting the length of your loan. — If you have 20 years left on a 30-year mortgage, for example, you may want to refinance into a 15-year loan for long-term savings. Your monthly payments may increase, but you will pay off your mortgage faster.
The advantages and disadvantages of refinancing a loan
If you’re considering refinancing, make a list of the benefits and drawbacks to see if it’s right for you.
- You could decrease your monthly mortgage to make more of your monthly budget.
- You could reduce the term of your loan and pay it off sooner.
- You could withdraw cash from the equity in your home at closing.
- You could consolidate debt — for example, some homeowners use refinancing to combine student loans and other debts into a single payment.
- You could convert your adjustable-rate mortgage to a fixed-rate mortgage, or vice versa.
- To avoid paying unnecessary fees, you may be able to cancel private mortgage insurance premiums.
- Closing costs must be paid.
- You may have a longer loan term, which will increase your costs and push back your payoff date.
- If you take cash out, you may have less equity in your home.
- If interest rates fall markedly after you close, you may encounter cold feet.
- It is not a quick process: refinancing can take anywhere from 15 to 45 days or more.
- Your credit score will temporarily suffer as a result.
Is refinancing bad for your credit?
There is minimal influence of refinancing a mortgage and that occurs for various reasons, such as:
- To determine whether you qualify for a refinance, mortgage lenders run a credit check, which appears on your credit report. A single question can deduct up to five points from your overall score.
- In addition to refinancing, your credit score may be impacted if you apply for other types of debt, such as a car loan or credit card.
- When you refinance, you close one loan and open a new one. Because your credit history accounts for 15% of your score, having one loan close and then taking on another shortens the duration, affecting your score.
In general, these effects will be felt for only a short time. If you’re worried about damaging your credit while comparing refinance offers, try to shop for loans within a 45-day period. Any credit pulls related to your refinance during this time period will be counted as a single inquiry.
Refinancing can be one of the most beneficial financial decisions you ever make. If you intend to stay in your home for an extended period of time, lowering your interest rate by more than half a percentage point can make a significant difference in your budget.