Refinancing Your Home Loan: A Beginner's Guide
You made it! Owning your own home is the American dream, and nothing quite compares to the feeling of having your own home, sweet home. With homeownership comes unique financial opportunities, such as refinancing your mortgage.
You have probably heard the term “refinancing" or “second mortgage" tossed around for years. But what does refinancing a loan mean? We asked executive mortgage banker Marc Laudicina, of William Raveis Mortgage, to explain how refinancing works so you can continue to build a solid foundation for your home equity—even if you decide to use some of it for your financial goals.
What is refinancing and how does it work?
“Residential mortgage refinancing is basically the transaction of replacing your current mortgage(s) with a new mortgage usually for a lower rate/payment and even a lower term in some cases—there must be a net tangible benefit to the borrower," says Laudicina. It's possible to “cash out" when you refinance, which could be applied to various expenses, such as home renovations, college tuition or paying off higher interest debt, such as credit card debt. The good news, which is a real benefit to homeowners, is that home equity loans generally have much lower interest rates than credit cards. There can be fees associated with the loan, similar to when you got your first mortgage. Some of these fees include an appraisal fee, inspection fee, attorney fee, homeowner's insurance and assorted other fees. Some lenders offer “no-fee" refinancing, but the interest rates are generally higher. (With Discover Home Loans, borrowers can enjoy a mortgage refinance with zero fees charged at closing and fixed rates from 3.99% - 11.99% APR*.)
Before you get started in your refinancing journey, check if your current mortgage has a prepayment penalty for paying off the loan early. “The borrower should always do some shopping for comparative offers based apples-to-apples scenarios," says Laudicina.
Why should you consider refinancing your mortgage?
A primary benefit to refinance your mortgage is often to get a better interest rate and term so that you pay less over the term of the loan. The savings could be significant. For example, let's say you have a fixed-rate loan of $200,000 at 6 percent interest over 30 years. Over time you will pay $231,640 in interest. If you switched to a 15-year fixed rate loan at 5.5 percent interest, it would result in $94,120 interest but your monthly payment will be higher. Paying even $50 more a month on your principal could save you $27,000 in interest costs. Cutting back on a few barista coffees per week to put more toward your loan payment could save yourself tens of thousands of dollars—so worth it.
When shouldn't you consider refinancing your mortgage?
“There always needs to be a 'net tangible benefit' to the borrower when refinancing—the absence of a net tangible benefit would definitely be a reason not to refinance," says Laudicina. Refinancing your home may not make sense if you would like to move from your home in the foreseeable future or you get unfavorable terms. Also, consider overall mortgage interest rates, which are impacted by the economy. When the economy takes a downturn, interest rates can be lower, making it a good time to refinance. Or the reverse, when the economy is booming, interest rates may be higher, making it a bad time to refinance, depending on your situation. So, certain scenarios could lower the financial benefit paid to you.
What are the benefits of refinancing?
Refinancing can offer many benefits to the homeowner. The most common benefit is a lower mortgage rate and term, known as a rate-and-term refinance, which may lead to paying less interest overall. If you are pursuing a cash-out refinance, the primary benefit is getting quick cash. Using that cash to increase the property's appearance and value is another benefit.
A quick look at the potential benefits include:
- Lower interest rate
- Shorter term
- Overall lower monthly payment
- Cash-out of home's equity
What are the risks of refinancing?
“A borrower should always feel comfortable with who they are working with, especially when dealing with their mortgage, and home in general, since a primary home is usually the borrower's most important asset/transaction," says Laudicina. “Even with all of the regulations that were added after the housing financial crisis, there are still practices in the mortgage industry that can be harmful to the borrower."
Be sure to scrutinize your loan fees to avoid overpaying for your refinancing. Shop around to compare offers.
What types of interest rates are there?
Some loans have fixed rates, meaning the interest rate and monthly payment is set for the term of the loan. Others are adjustable-rate mortgages (ARM), meaning the interest rate changes with the market over a set period of time i.e. 6 months, 1-year, 3-years, etc. and your monthly payment can go up or down. If you have an ARM, you may like to refinance to get a fixed-rate mortgage to gain the peace of mind that comes with knowing your monthly payment will stay the same.
There are many factors that can go into determining the borrower's interest rate such as credit scores, type of property
How do you secure a better interest rate when you refinance?
There are many factors that can go into determining the borrower's interest rate such as credit scores, type of property (single family home, multi-family, condo, etc.), if it is a primary home or vacation home, investment and the term of the current mortgage. The longer the term for the loan, the higher the interest rate is likely to be.
“Knowing or at least having a good idea of your credit history/scores is always beneficial and your scores/history should be checked at least once or twice per year," says Laudicina. “Always ask your mortgage professional what your scores are and for them to go over your report with you once they have it."
How does cash-out refinancing work?
Your home equity is the dollar value of what you own of your home. If your home is worth $100,000 and you have paid off $75,000, then your equity in your home is $75,000 ($25,000 mortgage remains). If you refinance for an amount greater than what you owe on your home, then you can get the difference out in cash. In this example, if you refinanced for $50,000, you could get $25,000 in a lump sum, called cash-out refinancing.
This can be a good way to get cash to pay off a higher-interest debt or expenses like college tuition. However, it does put your home at risk if you miss payments on the loan.
When are you eligible to refinance?
It's possible to refinance your mortgage even if the mortgage is still relatively new. You can also refinance multiple times. If you have a conventional loan, generally there is no waiting period to refinance. If you have a government-backed loan, you must wait six months to refinance. Other lenders can have particular terms on their loans, including a pre-payment penalty. You'll want to understand your current loan before you pursue a new one.
“Always keep an eye on current mortgage rates as best you can, which can be difficult during your everyday schedule," says Laudicina. “Staying in touch with your preferred mortgage professional definitely has its benefits so that you can check in on current options to save if and when the opportunity arises."