Mortgages last a long time, so it’s not uncommon to adjust the loan structure as your life changes. Learn when it makes sense to refinance your mortgage, how much you can save, and how much it costs.
The simplest answer is that a mortgage refinance works by giving the borrower access some of the equity in the property. This is the amount of value in the home the borrower owns (the rest of the value is covered by the loan itself). The borrower can use that equity to reduce the interest (and/or the term) of the loan by refinancing into a new, cheaper loan and paying off the old one. Or they can convert their equity to cash to use for home improvements or anything else. Or both.
A mortgage refinance allows you to replace an existing mortgage with a new one. The refinance can result in lower monthly payments, a reduced interest rate, or a shorter payoff term. You can even withdraw some of the value you’ve amassed in the home (the “equity”) and use it for renovations, or anything else.
You can reduce your mortgage payment without refinancing in a couple of ways. If you’re paying private mortgage insurance and have 20% equity or more in the property, you can ask your lender to end coverage and remove the charge from your payment. You can also ask your lender for a loan modification that reduces your payments. To do so, your lender may change the length of the loan, the interest rate, or even the principal amount.
The short answer is refinancing makes sense when doing so will save you money or allow you to make better use of your equity. But there are a lot of factors to consider before you refinance—and some math to do. Are you after a lower monthly payment or are you looking to shorten the length of the loan? Can you take advantage of lower interest rates? What will you do with the equity you withdraw? Will you be in the home long enough to recoup the costs of a refinance?
Ask your lender about the types of loans they offer and what ones are best for you. Get answers about interest rates and APRs. Ask about fees, discount points, and any other costs associated with the loan. Find out how long the process will take. Finally, if there is anything you are unsure about—ask about that. Your lender should be happy to explain.
The cost to refinance varies depending on the amount you’re refinancing, your credit score, and other factors. These costs consist of a variety of fees you’ll pay throughout the process—appraisal fees, application fees, origination fees. In general, though, you can expect to pay between 3% and 6% of the amount refinanced in closing costs. Some fees are negotiable, so you may be able to trim your closing costs.
A home equity line of credit (HELOC) allows you to borrow money by using your home's equity as collateral. Your lender sets a borrowing limit, and you can choose to borrow as much of that as you want for an agreed-upon period of time. It’s like a credit card or any other line of credit—you withdraw money as you need it, and you only pay for what you borrow.
A rate and term refinance, also known as a traditional refinance, allows you to change your interest rate, your loan length, or both. The refinance creates a new mortgage that pays off your existing mortgage.
A cash-out refinance will happen when you replace an existing home loan by refinancing with a new, larger loan. By borrowing more than you currently owe, the lender provides cash that you can use for anything you want. In most cases, the “cash” comes in the form of a check or wire transfer to your bank account.
PITI is an acronym that stands for "principal, interest, taxes, and insurance." Those four things make up most homeowners’ monthly housing payments.
An annual percentage rate (APR) is the interest rate you pay each year on a loan, credit card, or other line of credit. It’s represented as a percentage of the total balance you have to pay.
A real estate appraisal establishes a property's market value—the likely sales price it would bring if offered in an open and competitive real estate market. Lenders require appraisals when buyers use their new homes as security for their mortgages.
Mortgage brokers are professionals who are paid a fee to bring together lenders and borrowers. They usually work with dozens or even hundreds of lenders, not as employees, but as freelance agents.
Closing costs include payments to a variety of people and organizations for services during the homebuying process. Standard closing costs might range from 2%-5% of your home’s purchase price. But that depends on where you live, the property you’re buying, and other factors.
Home equity is the portion of your property that you truly “own.” Your lender has an interest in the property until you pay off your mortgage, although you’re still considered to be the homeowner.
A debt-to-income ratio is a measurement of your monthly income compared to your debt payments. Lenders often use this ratio to determine your creditworthiness.
A loan-to-value (LTV) ratio compares the amount of a loan you're hoping to borrow against the appraised value of the property you want to buy. Lenders use LTVs to determine how risky a loan is and whether they'll approve or deny it.
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