Refinancing a mortgage involves taking out a new loan that replaces an existing mortgage, or getting a new loan to pay off both a first and second mortgage. There are many reasons to refinance including locking into a lower interest rate, cashing out the equity in your home, or switching from an adjustable rate mortgage to a fixed-rate loan.
Refinancing usually requires having little monthly debt and very good credit, as well as money for closing costs.
One reason to refinance your mortgage is to cash out of your equity. This requires having a sizable amount of equity so you can refinance into a loan with a higher balance. This may be a good option if you want to pay off debt, pay for a large purchase, or pay to go back to school, for example. Cash out refinance loans typically have higher interest rates than regular refinance loans, but the rate will still be lower than most loans and credit cards. Remember that you will pay more in the long run, however, you will be paying on the loan for 15 to 30 years and the refinance can turn unsecured debt into secured debt.
The most popular reason to refinance a mortgage is to lock into a lower rate. If you want to take advantage of lower rates and lower your monthly mortgage payment, remember that your current interest rate should be around 1% higher to make it worthwhile, as you will pay closing costs on a refinance.
If you have an adjustable rate mortgage (ARM) that is about to reset, or you have a loan with a balloon payment, you may want to refinance into a fixed rate mortgage. You can also refinance to turn a fixed loan into an adjustable rate mortgage if you wish.
While refinancing can definitely be worth the time and cost, there are disadvantages to refinancing your mortgage. Always check the terms of your current mortgage to make sure you will not be charged a penalty for refinancing. If your loan has a prepayment penalty and you pay off the loan within the first two to five years, you may incur a high fee such as a flat fee, a percentage of the outstanding balance, or an entire month's interest, as the penalty.
Remember, you need to pay closing costs as well. It is important to use a refinance calculator to make sure it is worth it to refinance. A calculator can show you how long it will take to make the refinance pay off. As an example, you can expect to pay around $3,700 out of pocket in closing costs for a $200,000 refinance. Compare the savings you will enjoy each month to your closing costs to see how long it takes to break even.
A refinance works just like getting an original mortgage including verification of your income, credit, and employment. You will also need to decide which type of loan you want to refinance into, whether it is a 15-year fixed loan or an ARM.
It is not necessary to refinance with the same lender. You may wish to use a mortgage broker to help you get the best rate on your loan. You will need to have a home appraisal after you submit your application to make sure you have enough equity to justify the loan amount.
If you owe more than your home is worth, you can still refinance your mortgage. If you have less than 20% equity or you are completely underwater, the following may be options for you: