We hear it in commercials and see it on the news: “Rates are at or near historical lows. Refinance now before rates push higher.”
What does it mean to refinance? Refinancing is the act of taking on a new loan with different terms. Reasons for refinancing your mortgage include lowering your payment, shortening your term or using the equity you’ve built up over time to get cash back out of your home.
Lower Your Payment
Many people could benefit every month from having a lower mortgage payment. Some could use a little financial breathing room, some want to start a savings account, and others want to use the money to pay for other expenses. No matter your goal, there are a few different ways to reach it with a refinance.
This is pretty self-explanatory: The higher your interest rate, the more you’ll pay for your mortgage both now and in the future. A lower rate equals a lower payment if the length of the mortgage term remains the same. Check out this mortgage calculator to find out how much a lower rate could save you on your mortgage payment.
In order to refinance, you have to have a certain amount of equity in your house. If you owe more on your home than it’s worth because of a drop in property value, you may still be able to refinance.
Change Your Loan Type
If you have a fixed-rate loan, you might be attracted by the comparatively low rates offered by adjustable rate mortgages (ARMs). If you plan on being in the house for only a handful of years, this could make a lot of sense. Your rate is fixed for a certain amount of time at a low rate compared to a fixed-rate loan. Just have a plan in place for when your initial fixed-rate period ends.
Maybe you’ve decided you really like where you are. The neighbors are awesome and the school system is great. However, if you stay with an ARM past its fixed-rate term, you’re at the mercy of current market conditions. Your payment could go down, but it could also go up.
Many people expect rates will go up in the near future if the Fed decides to raise the short-term funds rate, the rate at which banks borrow money. To put it bluntly, when the cost goes up for banks, clients will pay the price in the form of higher interest.
If you find yourself tired of riding the surf that is the market, you may find that you can lower your payment by refinancing into a fixed-rate loan.
If you need a lower payment, you could also take a look at lengthening the term of your mortgage. It’ll take longer to pay off, but you’ll have a lower monthly payment that can help you out now. You may even be able to refinance to a lower rate.
Reduce or Eliminate Mortgage Insurance
Mortgage insurance protects the lender in case the borrower defaults on the loan. It can add a couple hundred dollars to your monthly mortgage payment. While no one likes paying the premiums, mortgage insurance makes it possible for many buyers to own their home without handing over a large sum of money for a down payment. It also allows current homeowners to refinance to a lower rate or a longer term – saving them money every month – even if their loan-to-value (LTV) ratio is over 80%. LTV is the amount of money you owe on your home compared to its current value.
As you can see, mortgage insurance isn’t all bad. And here’s the best part: Paying mortgage insurance doesn’t necessarily have to be a way of life the entire time you own your home.
Conventional loans can have private mortgage insurance (PMI), which you can ask your lender to remove once you reach an LTV of 80% or lower. On FHA loans, mortgage insurance might be with you for the duration of the loan, depending on when the loan was taken out. But, there’s good news; once your LTV reaches that magical 80%, you can refinance to a new loan that doesn’t require mortgage insurance.
If you can’t avoid mortgage insurance altogether, you may be able to save some money each month with a lender-paid mortgage insurance (LPMI) programs like PMI Advantage.
Pay off Your Mortgage Faster
Instead of lowering your payment, you may wish to pay off your mortgage faster and save money on interest you would have paid over the longer term.
You can refinance to a 15-year loan or even a custom-term YOURgage. Doing so will give you a higher monthly payment, but you’ll be able to pay off the loan faster and be in a better financial situation down the road, while saving quite a bit on interest. As an added bonus, shorter-term loans often come with a lower interest rate than 30-year options.
Take Cash Out
The third type of refinance allows you to convert your home equity into cash. You can then use the cash to pay for home improvement projects that may even add value to your home. Maybe you want to use it to put your child through college or make an investment with a higher rate of return than your mortgage interest rate.
The best part about a cash-out refinance is that, unlike a home equity loan, a cash-out refinance isn’t a second mortgage. This means it’s less risky for the lender and you can get a better rate.
You might also use the equity in your home to pay off debt.
As far as I’m concerned, credit cards are among the world’s great inventions. You don’t have to deal with cash or writing a check. You just swipe the plastic and pay the bill – in full. Carrying a balance on your credit card isn’t a great idea. The average rate on a variable interest credit card is 15.72%, according to the latest numbers from Bankrate. If you fall behind on a couple of cards, all that interest can add up quickly.
This is where doing a debt consolidation refinance could be helpful. Debt consolidation involves a cash-out refinance where use the equity in your home to get money to pay off your current debts. You then roll that debt into your mortgage payment at a much lower interest rate. (Rates are currently in the low 4% range.) From then on, you just have to make your mortgage payment on time and keep your credit card balances down.
Now you know what a refinance is and we’ve gone over the types. Do you think you might benefit from refinancing? Talk to one of our Home Loan Experts today and see if it’s right for you.
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