When you are thinking about refinancing your home, it will help to think of it as very similar to getting your original mortgage, but with a few extra steps. Essentially what you are doing is getting a new loan, which pays off the first one, but the new loan has more favorable terms, like a new interest rate. In the last year, interest rates hit a record low, which had many homeowners going to refinance their homes to save money on the life of their loans overall. There are many reasons to refinance your home, so you must know what you are trying to achieve with the process. Knowing your refinance goals will also help you know what to avoid when you refinance your home, such as not shopping around for different loans, not factoring in closing costs, agreeing to extravagant fees, cashing out too much, and more.
Knowing your goal before refinancing will help avoid mistakes that may cost you more money or make it not worth the time. Whether you are looking to get a better interest rate to lower your monthly payments, cash out some of your equity to pay off some debt, pay off your loan faster by changing it from a 30-year mortgage into a 15-year loan, or switch from an adjustable-rate to a fixed-rate, it is important to do your due diligence and shop around for different loans. When you were looking to buy a home in the first place, you had lenders present preapproval letters telling you how much mortgage you could afford. This time it is a Loan Estimate, which impacts your credit score, but if you apply for multiple at once or within two weeks or so, minimizing the impact on your credit score. After submitting the application and giving the lenders the basic information on you and your finances, they will have an estimate for you in three days.
This is how you will find out how much you can gain or lose on the refinancing of your home. A loan estimate will show you the loan terms, projected payments, fees, and potential closing costs. Shopping for multiple lenders while you are refinancing is so you can compare the fees and closing costs so that your break-even point for the refinance is worth it and reduces your costs. When you compare lenders, you can avoid ones with extravagant fees and then have reasonable closing costs. You want to make sure that you are prepared for closing costs since the most effective thing to do with closing costs is to pay them upfront out-of-pocket, and you want to make sure you have the money available. Depending on the lender, you could have the closing costs folded into the loan, but that adds to the loan you were working to lower. Again, comparing lenders is the best way to find an option for you that will best fit your plan.
The next thing you want to keep in mind when you are refinancing has to do with the cash-out refinance, which is where you take out a new mortgage to replace the original, and the difference goes to you in cash, which you can spend on whatever you choose. The important thing is that you need to have equity in the home already, meaning you have to pay in first before you can take anything out. The best way to explain this is with an example:
- Your original mortgage was for $300,000, and you have paid $120,000 over the last decade but are looking to update your home. You need cash for the upgrades, so you look to refinance your loan because you can pull some of that equity out, and it is a good time because federal interest rates are low. Your home is still valued at $300,000, and you have a balance of $180,000 left on your mortgage. With a cash-out refinance, you can refinance the remaining $180,000 loan for $220,000 and receive $40,000 to do the work.
While this money could be put to good use, like improving the value of your home or paying down credit card debt to save money in interest and raise your credit score, it is important to pay attention to closing costs. These added costs will take money from what you pulled out and make sure that you do not take too much. Because you are increasing the size of the loan, you are increasing your monthly payments. If you fall behind on that, there is a possibility of foreclosure. Also, if in our scenario above we refinanced for more than 80 percent of the value of the home ( $250,000 would be 83 percent), you will have to pay PMI or private mortgage insurance, which will cost you between 0.55% to 2.25% on your loan amount each year.
It could be a great time for you in your family to refinance, but make sure you consider all the options from different lenders to make sure that you avoid the simple mistakes when you refinance your home.
