Who is Considered To Be a Good Candidate for Mortgage Refinancing?
What do you call it when someone buys a house and is responsibly paying off their mortgage every month? You could call it “adulting.” But what if there was a way to be even more responsible and pay less? Or what if there was a way to take advantage of all that value in your new home? That would truly be adulting. Well it’s possible there could be a way—through a mortgage refinance.
When you refinance your mortgage, you’re essentially paying off your existing loan and taking out a new loan at new terms. Generally, there are two types of refinances – No Cash Out Refinance: to get a lower interest rate or a different repayment period, or Cash Out Refinance: to take advantage of the equity in their home. If you refinance with a lower interest rate or term, it could save you thousands.
For example, using an online amortization calculator, if you pay on a $300,000 mortgage loan at a 5% fixed interest rate over 30 years, you’ll end up paying $279,767. With a 4% interest rate, you’d pay only $215,608 in total interest over the life of the loan.
That’s a savings of $64,159. The other type of refinance, a cash-out refinance, replaces your existing mortgage(s) usually with a larger loan and new terms (amount of new loan is calculated based on your home’s current market value) and you then receive the difference back in cash.
In many cases, there are also refinancing costs like origination, application fees, and more, which according to BankRate.com are typically ranging between 2-4% of the new loan amount.
If you’re wondering when you should refinance your mortgage, consider if you’ll be in your house long enough to make back any cost of the refinance. Also, keep in mind that there are also options for a no closing cost refinance. Ask your chosen lender about different options and corresponding rates.
If you want to refinance, how do you know when you can refinance your mortgage? And should you?
When Can You Refinance Your Mortgage?
Depending upon whether you have a conforming or jumbo loan, your chosen lender may have guidelines around waiting periods for a cash out refinance. For example, you may see a rule in which you need to own the home for 6 months before you can take cash out of your home.
Odds are your mortgage is one of your biggest costs every month. Lowering your interest rate with a mortgage refinance could save you money, but it might not make sense for everyone all of the time. Ideally, your original loan was based on the best terms you could get at the time, so if nothing has changed in your financial situation and/or your existing mortgage rate is around current offered rates, then it may not make financial sense to refinance your mortgage. Check with your chosen lender to compare options.
An important factor lenders consider is the loan-to-value ratio (LTV). That’s the amount you want to borrow in comparison to how much your home is worth. Lenders typically like to see that you have at least 20% equity left in your home after the LTV calculation for a cash out refinance (this LTV requirement can vary depending upon different factors such as loan program, credit score, property type and more).
That means, for example, if your house is newly appraised by the lender at $400,000 and you want a new loan amount of $300,000, then your LTV is 75% and you have a 25% equity position.
Lenders will normally use the current market value to calculate the LTV for new loan eligibility and that’s why, if your home went up in value since your last appraisal, you might be able to take advantage of the additional value in a cash out refinance. You can use an LTV calculator along with Zillow to help figure out your estimated loan-to-value ratio.
The other factors that may determine your eligibility for a refinance are your credit score and your other existing debt. As you likely learned when taking out your original mortgage, your credit score and existing debt (AKA DTI) can have an affect on the interest rate and terms lenders are willing to offer.
If your credit score has improved significantly or you’ve paid off other debt since signing your original mortgage, then you may be able to get better terms.
Who’s a Good Candidate for Mortgage Refinancing?
As we discussed, when you took out your mortgage, your loan terms were based on your home value and financial outlook at the time. If your finances have improved since then, you might be able to get better terms now. If the overall housing market has improved in your area or if overall interest rates have dropped, then you may benefit from refinancing.
For example, during the housing crisis in 2008, interest rates averaged around 6% for a 30-year fixed
loan . But recently, mortgage rates dropped to a 31-month low. Your interest rate, however, will still vary based on your individual credit score, financial history, and other factors. If your income or credit score has gone up, then you may be a good candidate for mortgage refinancing.
Along with a lower interest rate, the added benefit of an increased income is that you may be able to tolerate the higher monthly payments that come with a shorter loan repayment term on a mortgage refinance. If you can afford to move from a 30-year to a 15-year fixed interest rate loan, then it could save you money in the long run.
If your home has sufficiently gone up in value as evidenced by a current appraisal on your home, you also may be able to refinance and eliminate the need to pay for private mortgage insurance (PMI) on your new loan. PMI is typically required if you have 20% or less equity in your house.
Homeowners who have a high debt balance may be good candidates for mortgage refinancing. For example, people whose income and financials prospects have improved since purchasing their home could consider mortgage refinancing of it improves their overall financial position.
Also if your rate is high, but rates are currently low, it might be a good time to consider refinancing. However, if your financial situation hasn’t changed since you bought your house, your rate is close to current market rates, or the house hasn’t gone up in value, then you might want to wait to refinance.
When Should I Refinance My Mortgage?
Often, homeowners refinance their mortgage in order to get a better interest rate. The other reason homeowners want to refinance their mortgage is to take advantage of the equity in their home and use the funds for various reasons.
The money from a cash-out mortgage refinance can be used for almost any reason but more common purposes are – to make improvements on your home, to fund an education or retirement, or even to pay off existing debt with less favorable terms or to lower overall monthly payments to budget. However, if you are considering different options to get the cash you need, you should know that there’s a difference between a cash-out refinance and a home equity line of credit.
Some indicators on when to check on the benefits of a new refi could be: if you have a higher loan amount and can reduce your interest rate by at least .5% with low or no cost options; to break even quickly; if you can afford to move to a 15-year mortgage; if the interest on your adjustable rate mortgage (ARM) is about to go up; or if you can use the cash-out refinance to pay off other higher interest debt.
When home values go up – this can be a good indicator on when to refinance because increased value can help you get better terms (such as removal of PMI) or you could potentially use the cash.
If you’re considering remodeling your home, for example, then a mortgage refinance can help you pay for it now with the goal of increasing the property value due to the changes you make to the home. (You can also use an unsecured personal loan to pay for things like renovations or to pay off credit card debt, which might make more sense if the terms are favorable and increasing the amount of your existing mortgage is not a good option.
Options for Mortgage Refinancing
In addition to traditional mortgage refinancing, there are a few other options for refinancing. There are two federal programs that help distressed homeowners refinance more easily: Fannie Mae’s High LTV Refinance Option and Freddie Mac’s Enhanced Relief Refinance . These programs are designed for homeowners who are current on their mortgage but have little or no equity in their home.
That means, for any number of reasons, they owe as much or more than the home is worth. These programs provide an opportunity for those people to mortgage refinance at better terms and save money.
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