Lucy Randall, a non-commissioned Mortgage Expert at Better Mortgage, gives a rundown of mortgage refinance and how to determine if one is right for you.
If you’re a homeowner, you might be hearing everyone, from your neighbors to news anchors, talking about refinancing. So should you be considering it too? There are many situations in which refinancing your mortgage may be right for you -- let's go over some of the major reasons:
First of all, what is refinancing?
When you refinance your mortgage, you are basically swapping out your old loan for a new one. There are two main types of refinancing:
- The remaining balance on your current mortgage is transformed into a new loan that has a better rate and/or term for your situation.
- You liquidate some of your home’s equity, creating a new loan that consists of your previous mortgage balance plus the cash you took out.
You can get a refinance from any mortgage lender you choose—it doesn’t have to be from your current lender. We encourage you to shop around when refinancing, just like you (hopefully) did when you first got your mortgage.
So why might you consider refinancing in the first place? It all depends on your goals. People choose to refinance for a diverse set of reasons, but here are some of the more common motivations I see:
1. I want to lower my monthly payments:
If rates have dropped since you got your original mortgage, you may be able to refinance into a loan with a lower rate. Doing so can reduce the amount of interest you pay and lower your monthly payments, meaning you’ll also pay less over the life of your loan. You can check today’s rates in seconds here.
If rates haven’t dropped significantly but you have had or anticipate a decrease in income, you may be able to lengthen your loan term to pay off your loan more gradually. For example, if you switch from a 15-year fixed mortgage into a 30-year mortgage, you can make lower monthly payments, though it’s important to note that you’ll also have to pay interest for a longer period of time.
Lastly, has the value of your home gone up, or have you paid off a good chunk of your mortgage? With that additional equity in your home, your new loan-to-value ratio (LTV) will be smaller, which may help you get a better rate regardless of current rate trends. Or if you currently pay mortgage insurance, but now have more than 20% equity in your home, you may be able to refinance to cancel your mortgage insurance payments.
2. My credit score has improved:
If your credit score has gotten a significant boost, you may also be able to refinance and get a better rate. For example, depending on the specifics of the loan, a 20-point increase in your credit score could reduce your rate and help you save thousands of dollars in interest over the life of the loan.1
3. The fixed period on my adjustable rate mortgage is ending:
While adjustable-rate mortgages (ARMs) can save you money on your monthly mortgage payment in the early years of owning a home, once the fixed period ends, your interest rate may increase significantly. You can avoid this by switching from an ARM to a fixed-rate mortgage. While your new fixed rate will likely be higher than your original adjustable rate, you’ll be protected from future rate increases. (On the flipside, if you know you’ll be selling your house in the next few years, switching to an adjustable-rate mortgage could lower your rate and monthly payments until the fixed period ends and/or you sell your house.)
4. I can afford higher monthly payments:
In some cases, changing the length of your loan when refinancing can be advantageous. If you can afford higher monthly payments, thanks to an increase in income, you could refinance into a shorter loan (such as from a 30-year fixed to a 15-year fixed) to pay off your mortgage faster, saving thousands of dollars in interest payments over the life of the loan.
5. I want to take cash out:
As I mentioned earlier, you can also do a cash-out refinance, which allows you to use the equity you've built in your home to borrow money at a low cost. People often reinvest that cash out back into their home to make improvements that boost their home’s value. Taking cash out can also be useful if you need extra money for expenses such as education or medical costs and do not have access to other funds.
So how exactly does this work? Let’s say your house is worth $300,000 and you have $100,000 left on your current mortgage. That means you have $200,000 in home equity. You could refinance to turn $30,000 of this equity into cash out. You would then get a new loan worth $130,000 (the $100,000 balance on your original mortgage balance plus the $30,000 you took out in cash).
Since lenders view cash-out refinances as riskier, interest rates are generally higher than those for rate-and-term refinances. However, you may still be able to get a better interest rate than your current financing even when taking cash out, particularly if rates have dropped or your credit score has improved since you got your original mortgage. To be eligible for a cash-out refinance, most lenders also require that your loan-to-value ratio (LTV) stays at or below 80% post-refinance (for a single-unit primary residence; maximum LTVs for other properties may vary). You can calculate your cash-out refinance LTV like so:
6. I want to consolidate debt:
Lastly, you can refinance to consolidate other debts into a single, more affordable payment. This can be especially helpful if you have high-interest loans and debts like credit card debt, student loans, or a second mortgage. A debt consolidation refinance is technically considered a cash-out refinance, so the two work in a similar way. Essentially, a portion of your home equity is turned into cash out that you can use to pay off other loans and debts. Your old mortgage will be replaced by a new one that includes the amount you took out to pay those other debts.
Consolidating credit card debt in this way can especially be advantageous because of the difference in credit card and mortgage interest rates. In 2015, U.S. households paid an average interest rate of 13.66% on credit card debt, while the average mortgage interest rate for that year was 3.85%, almost 10% lower.23 By moving your credit card debt to your mortgage, you may be able to save a significant amount from the lower interest rate in the long term. Mortgage interest is also usually tax-deductible, unlike credit card interest, offering another opportunity to save money by consolidating.
Since refinancing for debt consolidation is a form of cash-out refinance, you can expect to see higher rates than those for rate-and-term refinance, as well as a post-refinance maximum LTV of 80%, as I mentioned above. Note: while the interest rate might be lower, it may take longer to pay off that credit card debt when it is converted to mortgage debt and you should be sure to factor in closing costs when making your decision.
So what’s the verdict? Is refinancing right for you?
While there can be many benefits to refinancing, it’s important to remember that you’ll still have to complete a loan application and pay closing costs, similar to the ones you paid when you got your original mortgage. You’ll typically have to pay things like bank/lender fees, appraisal fees, and title insurance fees. (At Better Mortgage, we don’t charge any lender fees, so you won’t have to worry about that cost if you refinance with us.)
If you’re looking to get a better rate or term by refinancing, you should consider the break-even point: the length of time it will take for you to recoup the costs of refinancing. If you expect to remain in your current home beyond the break-even point, then it may be a good idea to refinance your mortgage. Otherwise, the upfront costs of refinancing won’t outweigh the potential long-term savings.
If you only plan to keep the home for a few more years, you may want to consider a “no-cost" refinance, where you offset your closing costs by raising your refinance rate (i.e. taking credits). Doing so can help you reduce your interest rate and monthly payment with no out-of-pocket costs. For a cash-out/debt consolidation refinance, you should also compare the benefit of how you’ll be using the money you take from your equity and the added time (and interest) it may take to pay off the loan.
Run the numbers
We have a handy refinance calculator that makes it easy to see your break-even point and how much you can save by refinancing. Once you create an account with us, you can also make your own Loan Estimates to see the breakdown of all the costs associated with your refinance depending on which loan options you are considering.
So long as your lender does not charge prepayment penalties or look for a “seasoning” period between your mortgages (establishing a certain time frame between appraisals), you can refinance as often and as soon as you would like. However, you should only refinance if it fits your personal/financial situation and goals.
Review your options
We’re more than happy to help walk you through your refinance options and find the right choice for you. You can schedule a call with one of our non-commissioned Mortgage Experts, or you can get started on your refinance journey here.