2020 was a big year for the housing market. As Coronavirus swept the globe and forced families to alter their lifestyles completely, priorities began to shift, and new opportunities arose for many potential home buyers. Interest rates dropped to near historic lows, and many homeowners took advantage of an opportunity to refinance existing home loans. For homeowners that missed the opportunity to refinance in 2020, the question becomes, “Should I refinance my mortgage in 2021?”
It’s a good question, but unfortunately, the answer isn’t as simple as yes or no. The decision to refinance depends on your personal and financial situation. For some people, refinancing won’t provide the intended benefits. There are also up-front costs you may not be prepared to pay. To determine whether to refinance your home, it’s a good idea to learn more about the different types of refinance loans available and why they’re used. This guide will help you understand how different refinance loans are used and how to compare your options to your current mortgage terms.
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When Is It a Good Idea to Refinance My Mortgage?
It’s typically considered a good idea to refinance a mortgage if you can lower your interest rates, shorten your loan term, or both. However, there are a variety of reasons homeowners consider refinancing. For instance, if, for some reason, you can’t keep up your current monthly mortgage payment, refinancing could help you avoid defaulting on your loan and facing foreclosure. Additionally, refinancing is a way to use the equity in your home while you’re still living there.
8 Reasons to Refinance
Homeowners choose to refinance their homes for a variety of reasons. Not surprisingly, many of these reasons have little to do with the terms of the current loan. However, the results of refinancing should be an improvement over your current mortgage. These are some common reasons to refinance.
Generate Funds for Major Renovation or Home Repairs
Home renovations can be expensive, but they increase the value of your home and how much you enjoy it. Refinancing a mortgage can allow you to access the equity in your home to fund your renovations or vital repairs.
Paying off medical bills or taking care of an emergency may require instant access to a considerable amount of money. If you’re eligible for a refinance loan, you can pay off your existing loan and use the remainder of the money to take care of an emergency.
Sending your kids to college includes expected and unexpected costs. Refinancing your home can put cash in your pocket (or your college student’s) to help you get through a difficult financial time.
Rolling your mortgage loan and other debts into one loan can mean an overall lower cost for paying the bills.
Improved Interest Rate
Recent drops in mortgage interest rates can lead to big savings over time. Refinancing for a lower interest rate is one of the most popular reasons.
Shorten the Length of Your Loan
If you’re making more money than you were in the past, you may consider refinancing with higher monthly payments to pay off your mortgage more quickly.
Lower Monthly Payments
If you’re facing temporary financial difficulties, refinancing can help you lower your monthly payments and avoid defaulting on your loan.
Converting Your Mortgage From an Adjustable to a Fixed-Rate Mortgage
If your financial profile has improved, you may be able to qualify for a fixed-rate loan instead of an adjustable rate. Fixed rates are usually preferred because they eliminate surprises.
Important Details About Refinancing
Refinancing your home is the act of obtaining a mortgage to replace your current mortgage. The details of your refinance loan will play a big part in the benefits you obtain.
Types of Refinance My Mortgage Loans Available
- Fixed mortgage: Refinancing your mortgage for one with better terms is a common choice. If your mortgage has an adjustable rate, you may be able to qualify for a fixed-rate mortgage instead. A fixed-rate mortgage means your interest rates will remain the same for the life of your loan.
- Variable mortgage: Also called an adjustable-rate mortgage, a variable mortgage means interest rates can change over time. Variable mortgages are typically used when rates are expected to improve in the future. They can also help borrowers with less-than-perfect credit get approved.
- Cash-out refinance: A cash-out refinance allows you to tap into your home equity. You’ll apply for a new loan bigger than the balance you already owe. After paying off your existing mortgage, you can spend the rest of the funds to take care of renovations, emergencies, or other expenses.
- HELOC: A home equity line of credit (HELOC) is a loan that uses the difference between your home’s value and the amount you owe on your mortgage as collateral. The use of your home as collateral usually allows borrowers to get lower interest rates and a better chance of approval.
- Rate and term refinance: The title rate and term refinance cover all the ways borrowers choose to refinance to improve the terms of their mortgage. This can include a lower interest rate, a fixed rate instead of a variable rate, lower payments, a shorter loan term, or improved options because you’ve improved your credit score and financial profile.
Refinance My Mortgage Loan Payment Terms
Like a regular mortgage, you’ll have options when it comes to the life of your refinance loan. The most common mortgage terms are 15-year loans and 30-year loans. Still, if you shop among lenders, you can find a variety of options.
A 10-year mortgage will allow you to pay off your home quickly and save a significant amount on interest. However, monthly payments will be higher, making it more difficult to qualify for a 10-year mortgage.
The second most common term for home loans, a 15-year loan, comes with higher payments than a 30-year mortgage, but you will pay less interest over the life of the loan. Additionally, interest rates are often lower for shorter loans.
A 20-year mortgage is more common for refinancing than for typical mortgage loans. This will often allow a borrower to pay off a refinance loan in roughly the same amount of time they would have paid off the original loan.
A 25-year mortgage may be used instead of a 30-year to save on interest costs and pay off a loan more quickly. It can also be a good choice for borrowers to pay off the home in a similar target time to the original mortgage.
The most commonly used loan term is a 30-year fixed mortgage. It creates affordable monthly payments for most homeowners and can usually be paid off early if you choose.
While it’s not available from all lenders, you can get a 40-year mortgage. A 40-year mortgage makes payments more affordable but means you’ll be paying more in interest over the life of your loan. It’s typically used for borrowers who wouldn’t be able to afford a home otherwise.
The closing costs of your mortgage loan are the costs beyond the downpayment that you must pay upon closing day. Closing costs can be 3.5% to 5% of the cost of your loan and may sometimes be rolled into the loan payments. These items make up the complete balance of your refinancing closing costs.
- Application Fee: Usually filed under miscellaneous fees, the application fee will likely be listed with the cost of registration and credit check.
- Prepaid Insurance: The first year of homeowner’s insurance is usually paid at closing.
- Prepaid taxes: Usually, 6 months of advance tax is paid at closing.
- Attorney Fees: Some states require you to have an attorney for a home purchase or refinance. These fees might be bundled into closing costs.
- Title Insurance: Title insurance is a one-time payment used to purchase a policy to protect against title defects discovered during a title search.
- Appraisal: An appraisal is generally required for all types of mortgage loans to ensure the home has enough value to cover the cost of the loan. The cost of appraisal/survey maybe hundreds of dollars and will be a portion of your closing costs.
- Points: Mortgage points are paid directly to the lender in exchange for lower interest rates.
How Do I Know if My Finance Loan Will Be Approved?
Simply owning a home doesn’t necessarily make you a candidate for refinancing your mortgage. Like all loans, you’ll need to meet certain eligibility factors, and poor financial habits can derail your chances of refinancing your home.
Eligibility Factors to Refinance Your Home
- Credit Score: All loans (including refinancing) require you to meet certain credit requirements. If your credit score has improved, you could be eligible for better terms than your original mortgage.
- Home Equity: Your home equity is the portion of your property you own, free and clear. It increases as you pay down your mortgage. Your home equity is determined by subtracting the amount you owe on your mortgage from the value of your home. You may be able to refinance with as little as 5% equity. However, interest rates and insurance costs are likely to be high unless you have at least 20% equity.
- Loan to Value Ratio: Your loan-to-value ratio (LTV) is the percentage of your home’s value that you still owe. It’s determined by dividing the amount you own by the current value of your home. Your LTV is used to determine your eligibility and whether you need mortgage insurance or other protections.
- Debt to Income Ratio: Your debt-to-income ratio (DTI) determines the percentage of income you receive that isn’t used to pay other debts. Your DTI is calculated by dividing the sum of all your monthly payments by your gross monthly income. Your DTI should be lower than 50% to refinance.
Reasons Your Refinance Loan Could Get Declined
- Non-verifiable income: If you’re self-employed or have non-traditional income, it can be more difficult to prove you have the income to meet the lender’s guidelines for a new loan.
- No job: If you don’t have monthly income coming in, it can be difficult to qualify for a loan.
- Bankruptcy: A bankruptcy in your recent history can make it difficult to qualify for refinancing.
- Delinquent payment history: Your lender uses your financial history to determine your ability to repay a loan. If your financial history includes late or missed payments, you may not qualify.
- Inability to meet lending guidelines: If your current income isn’t enough to meet the monthly payments, you won’t qualify for a loan.
Refinancing During Coronavirus: Concerns and Assistance
While Coronavirus has created some favorable conditions for homeowners wishing to refinance, there are also some notable financial drawbacks experienced by many people. If you’re one of the millions of Americans out of work, you face a two-fold problem. While a refinance loan could provide you with lower payments you could afford, lower income makes it more difficult to qualify for a loan.
The CARES act provided many homeowners with mortgage forbearance options. The option to modify your current mortgage is included within the mortgage relief options created by the CARES act. This could mean that homeowners who wouldn’t typically qualify for refinancing can use the clauses within the CARES act to refinance during times of hardship.
Frequently Asked Questions About Refinancing
How long does it take to refinance?
The typical refinance is expected to take around 30 to 45 days to complete. However, the exact length of time will depend on your individual situation and the many moving parts of refinancing. Some types of loans take longer to process, and certain actions (like an assessment or appraisals) can be delayed, extending the timeline.
Should I pay points for a refinance loan?
When you buy discount points on a mortgage, you can get a lower interest rate that lasts the life of your loan. However, since your payments will be reduced, it can take up to 10 years to recoup the costs of points. Therefore, you should only purchase points if you’re going to remain living in the home long enough to recoup the costs.
Is a cash-out refinance worth it?
When you use a cash-out loan for a specific purpose, it can be a useful tool. For instance, a cash-out refinance can allow you to take advantage of lower interest rates and provide you with the funds for a renovation to increase your home’s value. However, simply using your house for a piggy bank means your taking on risk for no reason and extending the life of your mortgage.
Do you start over when you refinance your mortgage?
Not necessarily. Refinancing means you replace your existing loan with a new one. However, if your new loan is for a shorter term, you’re not starting over. In fact, some homeowners choose a term that will allow the loan to be paid off within approximately the same time frame as the original loan.
What is the minimum amount of interest savings compared to current mortgages worth financing for?
It can be worth refinancing for as little as a 1% interest rate drop. In some situations, it may even be worth it to refinance for 0.5%. However, to recoup the benefits of refinancing at less than 1%, you’ll likely need to ask about a no-closing cost refinance loan.
Whether you’re getting a mortgage for the first time or refinancing your existing mortgage, obtaining the right insurance is an important part of the process. The independent insurance experts at LoPriore have experience in the insurance policies that protect you while refinancing your home. Get in touch today to learn more about insurance needed during the mortgage process and policies to protect your home and possessions over time.
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