Your mortgage can be a very powerful financial tool that can help you in a variety of situations. The major way you take advantage of the built-up equity and other financial power is by refinancing your home. But when should you do it? Are there any downsides?
The answers to these questions really depend on your goals and what you hope to get out of the refinance. In this post, we’ll go over several scenarios where you might refinance and how to determine if it’s right for you.
Why Should I Refinance My Mortgage?
There are a lot of reasons you might consider for refinancing your home. However, when we look at these transactions, they can really all be bucketed into four categories: lowering your rate, changing your term, changing the loan type or cashing out equity.
Lowering Your Rate
If you can get a lower rate, it’s always worth looking into refinancing your mortgage, particularly if your term is the same (e.g. going from a 15-year to another 15-year mortgage). The reason for this is that since everything else is remaining constant, if your rate goes down, your base monthly payment (not including taxes and homeowners insurance) will go down.
In many cases, this is a good deal that you should jump on, but before signing on the dotted line, there are at least a few things to consider.
Always be sure to look at the annual percentage rate (APR). This is generally listed to the right of the base interest rate and takes into account the base rate plus closing costs and other fees. The bigger the difference between the base rate and APR, the higher your costs will be to close this loan.
You should also be sure to factor in mortgage insurance costs. If these apply to your loan, you have to factor them in to your monthly payment. Of course, you could also refinance to get rid of mortgage insurance, but we’ll talk about that more below.
Changing Your Term
Another reason you might look at redoing your home financing is to change your term. You can go in either direction, a 30-year term to a 15-year term and vice versa. Let’s take a look at reasons you might go one way or another.
By going from a longer-term to a shorter-term mortgage, you’re going to see a lower interest rate. This is because mortgage investors don’t have to project inflation as far into the future, so you can get a better deal. You save on interest payments over the life of the loan. On the payments you do make, more money goes directly toward paying off principal, so you gain equity faster.
The flip side to this is that your monthly payment may be higher because you’re giving yourself less time to pay off the loan. This may or may not be the case for you. It all depends on how much you’re saving in interest and how many years are being removed from the term.
If you go from a shorter term to a longer one, you’ll get a slightly higher interest rate because investors have to take inflation into account over a longer term. However, you’ll have a lower payment than you would if you went with a shorter term.
Lengthening your term isn’t for everyone because it means you’re taking longer to pay off your mortgage and paying more interest over time, but if you’re in the right situation, it does mean freeing up money for other things that aren’t your mortgage payment.
For the sake of simplicity, we’ve talked about going between 15- and 30-year terms in this post, but with a YOURgageSM, you can choose any term you want between 8 and 30 years for a fixed-rate conventional loan. You can also choose between several term lengths for FHA and VA loans.
Changing Your Loan Type
Mortgage insurance is something that gets a lot of bad press. It’s a fee no one likes to pay on a monthly basis. At the same time, it enables mortgage investors to give you a loan with a lower down payment by giving them some protection in the event you default.
FHA loans have their benefits, allowing you to get into a home with as little as 3.5% down and FICO scores as low as 580.
The downside of FHA loans is upfront and monthly mortgage insurance premiums. These stick around for the life of the loan if you make the minimum down payment. If your credit is in good shape (620 or higher FICO) and you have 20% or more equity, you can lose these mortgage payments by refinancing into a conventional loan.
If you don’t have 20% equity, the insurance comes off once you reach that point if you’re current on your loan. You can also avoid monthly mortgage insurance payments on conventional loans altogether by opting for a lender-paid mortgage insurance (LPMI) option like PMI Advantage.
Cashing Out Equity
A house has a roof, walls, rooms and furniture. Beyond that, though, it has real monetary value and for most people may be their most valuable single asset. Anyone who’s bought a house knows just how much money was put into that transaction. Still, a sale isn’t the only situation in which the cash value of your home is realized.
Each time you make your monthly payment, you gain a little bit more equity as you come closer to paying off your home. You can use this arrangement to your advantage by cashing out some of the existing equity in your home and putting it toward other items.
One common cash-out refinance scenario is a debt consolidation. Let’s say you have a couple of credit cards you’d like to pay off. Current variable credit card interest rates are above 16%. By taking cash out of your home to pay off these balances, you’re paying off the debt at a rate just over 4% in the current interest rate environment. It’s a much better financial position to be in.
You could also take cash out to make home repairs or finance a renovation. Alternatively, you might choose to give your retirement fund a boost or give your child’s college fund one last lift before they leave for school. It’s completely up to you.
The important thing to consider with a cash-out refinance is whether you have enough equity to accomplish what you want to get done by taking cash out. This is especially important because mortgage investors do require that you leave a minimum amount of equity in the home.
With conventional and FHA loans, you need to leave at least 20% equity in your home on a cash-out refinance. VA loans allow you to cash out all of the equity in the home conforming loans, but only eligible active-duty service members, veterans and their surviving spouses with 680 meeting FICO scores qualify to borrow the full appraised value.
How Much Money Will I Save by Refinancing?
Another key question most people have when choosing whether to refinance is how much money they’ll save. While it’s impossible to answer that question in a blog post because everyone’s situation is different, you can use our refinance calculator to get an idea of whether it makes sense for you.
If you like what the calculator shows you, you can get started by applying online with Rocket Mortgage® by Quicken Loans. If you’re more inclined to get started on the phone, one of our Home Loan Experts would be very happy to take your call at (800) 785-4788. If you have questions for us, you can leave them in the comments below.
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