If you want to take the opportunity of low interest rates or to lower your monthly home payment, you should consider refinancing your mortgage. However, refinancing is not always the best option, and whether you will truly benefit from refinancing largely depends upon the amount of your principal loan. Sometimes lenders may not disclose all information and fees regarding a refinancing option, and your refinancing may end up providing you no significant benefit while wasting your time and money. If refinancing seems to be a smart financial decision, it is better to proceed carefully during each stage of the process. Refinancing can be accomplished in four major steps.
Step 1: Verify your credit score
Verify your credit report and score before making an application for a refinance loan. Make sure they are correct before applying.
When attempting to refinance, you are trying to replace your existing loan with one which has better terms and rates. It is, therefore, important that you ensure your credit score is accurate so that you can qualify for the lowest interest rate possible.
Your credit score is calculated using data held by three credit companies (Experian, Equifax and TransUnion). These companies take into account your personal information as well as your credit payment history in order to calculate your credit score. From the data they possess, a credit score is determined and will range from 300 to 850. A credit score of 300 will be deemed rather poor, whereas 850 represents the best credit score achievable.
When looking at a refinance request, a lender will use your credit report and credit score to decide how to proceed with your application. If your credit score is low, lenders will compensate for the higher risk by offering you a higher interest rate or by reducing the amount you are allowed to borrow. This is the reason why you need to ensure your credit report is accurate. If it contains inaccuracies, a higher interest rate may be offered and may not reflect your personal circumstances.
Occasionally a credit report may contain errors; this is often the case with people who have similar names or social security numbers. If you spot a mistake on your credit report, it is crucial you inform the credit companies so that the information can be corrected. Because this can be a lengthy process, you need to do this well before applying for refinancing.
And remember, each of the three credit companies will let you have a free credit report once a year. A free credit score is also available if you sign up for a trial membership in the RateWinner Credit Monitor program.
Step 2: Find the refinance loan which is suitable for you
Learn about the different mortgage refinance loans and choose the one which is appropriate for you
Refinancing usually signifies setting up a new mortgage in order to pay off an existing mortgage. You may wish to refinance in order to reduce your monthly payments or benefit from a lower interest rate over the life of your loan. You may wish to make use of the equity in your home to finance your children’s education. The reason why you wish to refinance will help you decide which kind of mortgage is suitable for you.
Before choosing a refinance mortgage, you should make sure you understand the different types which are available as well as the benefits and costs associated with each type.
What refinancing option should you choose?
1. Rate and Term Refinancing
In the majority of cases, individuals opt for refinancing to reduce their monthly payments, to pay their mortgage off more quickly, or to lower the rate of interest applicable to their loan. Usually the loan amount remains unchanged. This is known as rate and term refinancing and it may be suitable in the following cases:
● To benefit from a better fixed interest rate
Refinancing may enable you to benefit from a lower interest rate and monthly payments if interest rates are lower than they were when you first took out your mortgage. For instance, a $120,000 fixed-rate mortgage on a 30-year term at 8 percent equates to a monthly payment of $881, whereas a refinance mortgage at 6 percent would reduce the monthly payment to $720.
● To benefit from a fixed interest rate
If you have an adjustable rate mortgage and have noticed that the interest rate has regularly gone up, you may wish to lock in the interest rate for a certain period. Although the rate may be slightly higher to start with, you will not be affected by further potential interest rate increases.
● To benefit from better loan terms
Your credit score may have improved since you first took out your mortgage loan. Refinancing may entitle you to a better interest rate. If you have an adjustable rate mortgage, a different cap (how much the interest rate can increase) may be applicable.
● To build your home equity at a faster rate
If your financial situation has improved since you took out your mortgage, you may wish to raise your monthly payments in order to pay off your loan more quickly. You could, for instance, refinance a 30-year $150,000 mortgage at 6 percent with a 15-year $150,000 mortgage at the same rate. Although your monthly payment would increase from $900 to $1,266, you would be able to pay off the principal in half the time and save approximately $96,000 in interest over a 15-year period. You can also build equity at a faster rate without the need to refinance by simply increasing principal payments every month.
● To lower your monthly payments
If you are struggling with your monthly payments, you may choose refinancing in order to benefit from longer payment terms. For instance, refinancing a 15-year $100,000 mortgage at 7 percent with a 30-year $100,000 mortgage at the same interest rate would decrease your monthly payments from $900 to $667.
2. Cash-out Refinancing
You may wish to replace your existing mortgage with a mortgage which carries a larger principal. This is known as cash-out refinancing. This option enables you to free some cash from your home equity while at the same time benefiting from a lower interest rate. This is possible because the loan is secured on your property. You may choose this option for several reasons:
● To release cash instead of taking out a personal loan
You may have built up a significant amount of equity after many years of mortgage payments and may, for instance, wish to free up some money for your children’s education. Instead of opting for a personal loan, which is usually associated with a higher interest rate and does not confer any tax advantages, you could choose to refinance your mortgage and increase the principal.
● To consolidate debt
You may have accumulated credit card debts at an interest rate close to 18 percent and may opt to refinance your mortgage and add your credit card debt to the principal to benefit from a lower interest rate of around 6 percent. Refinancing will enable you to consolidate your debt and allow you to pay it off at around a third of its present rate.
● To combine a mortgage and a home equity loan
If you have both a mortgage and a home equity loan with two different lenders, you may wish to increase the principal on your mortgage in order to pay off your home equity loan and get an overall better interest rate.
Is refinancing appropriate for you?
Because refinancing involves a cost, it may not be suitable for you. In fact, the benefits of refinancing are realized over time and if you are planning to move in the next few months, the potential savings associated with refinancing are unlikely to be realized. Also, refinancing may extend the time it takes to pay off your mortgage. As a rule, the longer you anticipate to live in your current home, the more suitable refinancing becomes.
Step 3: Look at various refinance offers and calculate when you will break even
Determine how long it will take you to break even after refinancing and compare the various refinancing offers available from lenders. If refinancing is suitable for you, you need to compare the offers available from various lenders and calculate when you will break even.
The break-even point
Ultimately, calculating how long it will take you before you start saving money will help you decide whether refinancing and its associated costs are worthwhile. First of all, calculate how much money you will be saving each month if you decide to refinance. Then work out the costs you will incur when refinancing and divide these costs by the monthly savings. The result will indicate how many months it will take to break even.
For instance, you have calculated that your monthly payments will decrease by $250 if you decide to refinance and that the total costs associated with refinancing add up to $5,000 (prepayment penalty + closing costs + discount points, etc.). In this example, it would take you 20 months (5,000 divided by 250) to break even.
When you break even may also be affected by other factors, such as your tax situation and whether your closing costs must be paid upfront or will be added to the principal of your new mortgage. If the value of your home has increased when you decide to refinance, you may no longer need private mortgage insurance and consequently save even more money.
Looking at the different offers
When looking at the various refinancing offers available, you must pay particular attention to the interest rates, as even a small interest rate difference between one offer and another can translate into thousands of dollars over the duration of a loan. Check whether the rate you are offered is inclusive of discount points (the sum payable upfront in order to obtain a lower interest rate).
Apart from the interest rate, make sure you also compare the annual percentage rates (APR). The APR includes the interest rate and other payments levied by the lender over the life of the loan, which are expressed as an annual percentage. Study the breakdown of each APR calculation in order to be able to compare loans on an apples-to-apples basis, as not all lenders quote an APR that includes every single fee.
Make sure you ask for further information if you are not sure about something and do not forget to compare lock-in terms, closing costs and associated fees and whether a prepayment penalty applies. Ideally, you should try to obtain a Good Faith Estimate (GFE) for each loan you are considering.
Step 4: Close your refinance mortgage loan
Closing a refinance mortgage loan is, in general, easier than completing a house purchase and you are unlikely to encounter many hurdles.
Before granting you a loan, your lender may wish to reappraise your home, since the appraisal will be used to calculate the amount of money you are allowed to borrow and will ensure your property is worth more than the value of the loan. If your loan-to-value ratio is below 80%, you should be able to cancel your private mortgage insurance policy when you refinance.
Once your home has been reappraised, the closing process should be straightforward. You should do your best to review all the paperwork prior to closing your refinance mortgage loan.