A mortgage is a consumer loan that helps you buy a house and you can get one from a bank, credit union, or an online lender. However, you will pay back within a timeframe using a fixed or variable interest rate.
But the interest rates are constantly changing. This is because the rates are subject to the demand and supply of money. And this brings us to the concept of refinancing.
Refinancing refers to paying off your existing debts using a loan with an interest rate lower than your current one. It is an option for borrowers to save money or extend their payment duration.
Mortgages are one of the most popular loans amongst borrowers. 64.8% of homeowners in the US have a mortgage, according to US Census.
So, learning about refinansiering gjeld (refinancing debts) can help you save money on your mortgage. And we will be covering this in the sections below.
Understanding Mortgage Refinancing
A home loan refinancing helps you change your existing loan terms for a much better one. For instance, you can take a refinance option with a lower rate than your current mortgage rates.
Also, you can increase the repayment duration to enable you to repay smaller amounts over a longer period. This way, you reduce pressure or you can increase the repayment duration to pay faster and become debt-free.
Taking a refinance is a good option. However, it comes with a few setbacks.
For example, your credit score will be affected a bit. And you might pay some prepayment penalties for clearing your mortgage before the agreed time.
All these setbacks can make you wonder whether it is worth it. But a good understanding of the dos and don’ts of refinancing can help you avoid possible future regrets. So, we will outline below when you should or should not refinance your mortgage.
When You Should Refinance Mortgages
You can take a refinance if:
- You have a good credit score. This is because the goal of refinancing is to get the best rates. But this is only possible with a good credit score – say at least 700. The best lenders provide rates of 2.5% to 3% with a down payment of 20% and a credit score of at least 710. And this is lower than the average mortgage rate of about 5.6%. You can watch this video to learn more about mortgage loans and rates.
- You want a time extension. Repaying a loan might be financially stressful, especially if your monthly income does not match the monthly repayment terms. In this case, you can take a refinance and extend the new loan period. This way, you can pay in smaller installments and reduce the financial pressure.
- You want to save some money. Lower rates can help reduce the amount you repay and help you save on the new loan.
- You want to lessen your repayment time. Lenders do not allow you to change loan terms like repayment period. However, you can take a refinance with a shorter repayment duration to pay for the old loan. And this helps you save because you clear out your debt in less time.
- You have good financial habits. There is no need to take a loan in the first place if you have no intentions and plan to pay it back. A healthy financial habit means early repayments and keeping to deadlines. And this also contributes to your credit score.
(There is no limit to the number of times you can refinance your mortgage. However, your lender might have a specific waiting duration before your next refinance.)
When You Should Not Consider Refinancing
A few times, the best option is to avoid taking a refinance. And we have highlighted a few of them below.
You should avoid taking a refinance if:
- You have poor financial habits. This includes not keeping up with repayment deadlines or making unnecessary expenses and luxury purchases.
- You have a low credit score. Your score reflects your financial habits and decisions. And this is what lenders look at before granting a loan request. A credit score that is below 600 can mean getting loans with higher rates. In short, you have fewer chances of getting a better rate.
- You have refinanced more than twice. While this is not a rule, refinancing a loan continuously affects your credit score. This is because lenders always do an inquiry on your account every time you apply for a refinance. And doing this will lower your score. Also, prepayment penalties and other charges add up to the loan and slowly take away the benefit of refinancing.
Requirements for Refinancing Mortgages
There are several requirements for refinancing home loans. And while each lender will have their specific ones, the general requirements include:
- Closing Costs: A closing cost is a fee that includes the cost of processing your mortgage and other charges. And they usually take up at least 5% of your loan. However, your lender might require you to pay these costs before refinancing.
- Credit Score: Your credit score and history is a major requirement. You will need at least a 630. However, VA (Veteran Affair) or FHA (Federal Housing Administration) loans can approve you with a score of at least 580 and a good credit history.
- DTI (Debt-to-income ratio): Your DTI refers to the ratio of your total monthly debts to your gross income per month. It is one of the ways lenders assess your financial behavior as it shows how much you spend monthly. Your DTI should be below at most 40% before submitting your application.
- Home Equity: Home equity refers to the difference between the amounts your house is currently worth and the mortgage amount. For instance, if your mortgage is $100,000 and your home is currently worth $300,000, your equity equals $200,000. Lenders will require that you have at least 25% of equity before applying.
Five Popular Types of Mortgage Refinance
There are several types of mortgage refinance. And understanding them can help you make the right decisions. Below are some of the popular types:
This type of refinancing is also called a no cash or limited-cash-out refinance. And it is one of the common types you can get from a lender. In short, it is the ideal definition of a refinance. In other words, you use it to replace your old loan terms.
Low home equity and a higher LTV (Loan-to-value) ratio can stop you from getting a rate-and-term refinancing. This is because lenders require that you have at least 20% equity, making the LTV ratio 80%.
But what do you do if you are in dire need of a refinance but have low equity? This is what cash-in refi helps you resolve.
A cash-in refinance means putting in money to make up your equity percentage. For instance, your current equity is 10% if your home is currently worth $200,000 and you owe $180,000.
However, you can increase your equity by making a down payment of $20,000 to boost your home equity by 10%. Therefore, your equity becomes 20%, and your LPV percentage is 80%.
Cash-out refinancing – unlike cash-in – you have extra money left after refinancing your mortgage. And this is ideal if you have more than 20% home equity.
For instance, if you have $100,000 left on your mortgage and 40% equity ($80,000), you can take out an additional 20% ($40,000) of your equity. So the highest you can get is your mortgage ($100,000) plus your 20% home equity, totaling $140,000. You can click on https://www.nerdwallet.com/ to read more about cash-out refinancing.
This type of refinancing requires you to refinance within the same kind of mortgage. For instance, you can refinance from a VA loan to a VA loan.
Streamline refi is best for those with low credit scores, equity, or DTI. This is because lenders will not check for any of the usual requirements.
However, streamlined refinancing is not available to regular mortgages. But you can use it to refinance government home loans through the Veteran Affairs, USDA, or Federal Housing Administration.
Usually, you will have to pay an amount as a closing cost after the approval of your new loan. However, it is not so with a no-closing-cost refinance.
You can avoid paying to close your new loans immediately after approval in a no-closing-cost refi. However, it will be in your interest rate or mortgage.
Effect of Refinancing Your Mortgage
There are several benefits you can enjoy by refinancing your home loan. However, there is also a downside to this. We will discuss more below.
Advantages of Refinancing Mortgages
Some benefits include:
- Lower rates: This is one of the primary reasons to take a refi. You can enjoy lower interest on your new loan since rates are not stable. For instance, you can refinance a mortgage of 5% interest with that of 3.2%. So, you save over 1.8% monthly.
- Liquidate your equity: You can liquidate some of your home equity with a cash-out refi option. However, you will need your equity to be more than 20% to use this option. You can use the fund for other vital expenses or invest it.
- Clear off your home loan in less time: Changing your loan term can also include reducing the payment duration. So, you can cut your repayment timeframe from 30 to 15 years. This way, you pay less interest over time and clear the debt faster.
Disadvantages of Refinancing Mortgages
Some setbacks to consider include:
- It affects your credit card: Although the effect is temporary, you might want to consider this if your credit score is low or if you want to take a new loan soon. Lenders do an inquiry before approving your loan. And this reduces your credit score temporarily.
- Prepayment Penalties: Prepayment penalties are charges your lender imposes for clearing off your debt before the agreed repayment duration. Some loans have this, and you may have to add it to the new loan amount before applying for it.
Refinancing your debt is not compulsory. However, some conditions call for it. So, ensure you understand whether it is the right thing to do before applying. Also, avoid taking loans without a financial plan.