The past few years have been great for the housing market. After bottoming out in 2011, the market (and economy) has really seen a surge especially in major cities like Washington D.C., San Francisco, Chicago and Seattle. With that resurgence, there have been tons of first-time homeowners making down payments and finally being able to afford a house, townhouse or condo they can call their own.
But simply owning a home isn’t necessarily the end of the process. Despite how great that 3 bedroom craftsman is, monthly mortgage payments can be difficult to manage at times. Especially when you consider things like changing jobs, having a kid (or many), buying a car.
Fortunately, a strong housing market has afforded plenty of lenders and refinancing tools that can put refinancing your mortgage within reach. If you have gained in equity in your home or improved your credit dramatically in recent years, then you might be able to lower your monthly mortgage payment or even shorten the life of your home loan.
This mortgage refinancing guide is designed to help you accurately assess your current situation and walk you through the process of refinancing your home.
Taking out a mortgage to buy a home is typically the largest piece of debt we will take on in our lifetime. For those of you who own a home, townhouse or condominium, you understand what I mean. Whether you are borrowing $100,000 for a small townhome, or $600,000 for a killer townhouse in Seattle, taking out a mortgage is an important move that needs careful attention from planning to execution to management.
Owning your dream home can offer a ton of benefits and can be a killer investment in the long run, whether it’s your residence or a rental/investment property. Unfortunately, life can throw lots of different things at you potentially making monthly mortgage payments difficult, if not impossible. High interest rates, an unstable economy, and unexpected expenses can all put your current mortgage payments in a new perspective.
Fortunately, mortgage refinancing is a tool available to homeowners looking to lower their monthly mortgage payments by obtaining a better interest rate and loan terms. This guide is aimed at walking you through the many things to consider if and when you are looking at refinancing your mortgage.
Before we dig any deeper, I want you to keep in mind that refinancing is a powerful financial tool that can be effective when used the right way. It has the ability to lower monthly payments and provide access to better loan terms for qualified homeowners but isn’t always the best solution for everyone. As with any big decision you make, the key is to understand all of your options, know which resources are available to you, and think critically before signing the dotted line.
With that being said, there are excellent mortgage refinancing options for in today’s market. To help you better understand your current situation, let’s cover some mortgage basics.
Put simply, a mortgage is an agreement through which a bank or other creditor lends a chunk of cash (with interest) to someone purchasing a property. That’s not to say that everyone relies on loans to purchase property. Being flush with enough hard-earned cash to buy a home straight up is a luxury that some enjoy. But if you are a homeowner, chances are you relied on a 15 or 30-year mortgage to buy your home.
Fixed Rate Mortgage Loans are pretty self-explanatory. With a fixed-rate mortgage, you pay the same interest rate over the entire life of the loan. It doesn’t matter if you have a 15 or 30-year mortgage, the interest rate will stay the same ensuring your monthly payments are consistent. It will never change.
Adjustable-Rate Mortgage Loans (ARMs) feature an interest rate that changes, or adjusts, over time. Often times these loans start off with a low fixed-rate for a period of time – about 5 years or so. But over time, that initial rate will change and potentially go up, thus adjusting your monthly payments.
The differences between these fixed and adjustable-rate mortgages are stark. Going with a 30-year fixed-rate mortgage provides people with consistency on the size of monthly mortgage payments being made. On the flip side, you will pay more in interest with a fixed-rate when compared to the initial interest rate with an adjustable-rate mortgage.
Choosing between a fixed and adjustable-rate mortgage loan helps set the framework for paying off the loan. But who offers and backs the different types of mortgages? Another important decision to make is between a government-insured and conventional loan.
Government-insured mortgages are exactly that, guaranteed by the Federal Government. Let’s take a look at some of those options:
FHA Loans are offered through the Federal Housing Administration’s (FHA) mortgage insurance program, which is run by the Department of Housing and Urban Development (HUD). First-time homebuyers often use FHA loans as they allow you to put down as little as 3.5% for a down payment. But they are not just available to first-time homebuyers – they are available to all sorts of borrowers. As with all other government-insured mortgage programs, the lender is protected against losses stemming from a borrower defaulting on their loan.
Remember, putting down a small down payment like 3.5% means you will need mortgage insurance, resulting in higher monthly payments.
If you or your spouse serves in the military, the U.S. Department of Veterans Affairs (VA) offers a loan program that can provide up to 100% of financing for your home. That means military families can purchase a house or condo without putting any money down, at all.
The U.S. Department of Agriculture (USDA) offers a loan program for rural borrowers through its Rural Housing Service (RHS). The key to this program is borrowers must meet some pretty specific income requirements to be eligible for a USDA mortgage loan. A borrower’s income must be no higher than 115% of the adjusted area median income. This program is designed for borrowers who have low or modest income, who have trouble securing a conventional loan.
The amount of your mortgage loan can also dictate the type. A conforming loan is less than $417,000 while anything over that amount is considered a jumbo loan. Conforming loans have slightly lower interest rates. Conforming loans meet the underwriting guidelines of Freddie Mac and Fannie Mae – two government-backed companies that buy and secure mortgages. The absolute maximum for an FHFA conforming loan is $625,500, though until 2011 that limit was as high as $729,750.
When refinancing your mortgage you are essentially swapping out an old loan for a new one. Refinancing effectively pays off the original loan and replaces it with a loan that (hopefully) comes with better terms. As we’ve touched on already, the motivation for refinancing comes from wanting to pay less money each month and over the life of the loan – usually 15 or 30 years.
But what really starts the process of even deciding to refinance a loan? I mean, I know that everyone wants the lowest possible interest rate and to pay as little as possible. So why wouldn’t everyone refinance…all the time? The answer is only a few things can make you eligible to receive a loan with a lower interest, and the main factor is probably obvious: your credit. It’s not hard to imagine that after a few years of owning your home, crushing it at work, and paying off other outstanding debts, that your credit could shoot for the sky. And as that credit continues to improve a bank or lender will continue to see you as an even ‘better borrower’ than you were before.
Refinancing, or getting a new mortgage to take over your original loan, is called refinancing. As we’ve already covered, refinancing is the only way you can get a better interest term and rate, and even convert your current mortgage from a variable loan rate to a fixed.
If you have good or excellent credit, or have improved your financial health, then refinancing could be a great option. But what about folks with bad credit, or have taken on more debt since taking out the initial loan? In those instances, refinancing can be risky. Before jumping in with both feet, it’s important to assess your own finances and understand exactly what the lender is looking at in determining your eligibility to refinance. In some instances, refinancing can even lead to a higher interest rate, instead of lowering it.
Ideally, you can establish a good rapport and working relationship with your lender. This will help open a line of communication with your lender, giving you all the opportunity in the world to understand exactly what the lender is looking for when considering your refinance. If you have pressing questions or need help understanding something, it’s always better to have an expert available to provide those answers.
Use this mortgage refinancing guide to better understand YOUR situation before making the decision to refinance.
Before you go out and try to refinance, know there may be timing restrictions that you’ll have to contend with. Each lender will have it’s own terms and conditions, so be sure to check with yours to see if there’s a 12 month waiting period or longer.
When refinancing, your new loan can offer a surprising number of benefits, including:
Check out the loan refinance calculator below to see how your monthly payments can change with different interest rates and loan duration:
In addition to obtaining a better interest rate on your home loan, refinancing can also give you access to cash for other purposes. Paying off credit card debt and buying a new car can be in the cards through a new refinanced loan. Now, it’s not as though a lender is going to give you free cash to spend as you please. Instead, equity is taken out of your home. After your house is appraised, the lender will decide how much of that appraisal they want to loan out to you. Once the original mortgage is paid off in full, the remaining balance of the refinancing loan is paid to you, the borrower. This can actually result in your home increasing in value at the same time.
Finding a great rate is easier said than done. For those of you who feel overwhelmed by the whole idea of refinancing, it’s so important to utilize every tool available to make the process easier. One of those tools is a mortgage refinance calculator, and chances are you’ve seen one while browsing various finance websites. And rightfully so. Mortgage refinance calculators make shopping for the best mortgage that much easier.
Now, the calculators won’t do EVERYTHING for you. It helps to know your new interest rate and loan amount, along with any potential fees you expect. Once you have this basic data in place, the calculator will give you a bunch of great information including new monthly payments and savings, overall savings, among other things.
More generally, refinance calculators will help give you a better handle on the resulting terms of your refinanced loan.
Before jumping into the process, take your time to really think and consider WHY you are refinancing. In other words, what is your goal?
It’s probably obvious that lowering your payments and saving money over the life of the loan is everyone’s goal. But how you get there can be tricky depending on the decisions you make during the refinancing process. For instance, refinancing your home over another 30-year loan can be attractive since it will result in substantially lower monthly payments, especially with a nicely negotiated new mortgage rate.
But how does that compare to a shorter life of the loan, like 15 years? As we covered before, extending the loan over 30 years might result in lower monthly payments, but ultimately you will be paying more in interest over the life of the loan as that principal balance takes up another three decades to wipe away.
If you can get a low-interest rate, consider refinancing your loan in a shorter period of time. It will help you pay less in interest. As always, it’s a fine balancing act finding that loan with an appropriate monthly payment and reducing your overall costs.
Earlier we covered adjustable-rate mortgages and fixed-rate mortgages. Adjustable-rate mortgages are helpful in producing low monthly mortgage payments when you first own your home. As you’d expect, those interest rates can easily go up along with your monthly payments the longer you are paying off the loan. If you want the stability of having the same payment month-in, month-out, then switching to a fixed-rate mortgage might just be for you. This is especially satisfying as you sit back and watch interest rates track like a roller coaster.
If you are doing well financially and find yourself in a position to pay-off your mortgage sooner rather than later, then switching your fixed-rate mortgage to an adjustable-rate mortgage can be a powerful way to save you thousands of dollars in paying off your home. It can help get you to 100% equity in your home fast – provided those higher monthly payments don’t come as a shock.
Refinancing your home is not without risks, unfortunately. It’s not necessarily a big concern, but worth covering. In some cases, using home equity credit to pay off your existing mortgage can actually cause you to incur penalties. Some mortgage agreements allow lenders to charge fees when taking this step. So check on your current mortgage agreement and make sure that the overall refinancing costs are worth the potential financial gains from refinancing.
Hopefully, you now have a better handle on all of the important considerations to make when refinancing your home, or even if you’re just thinking about it. As you’d expect, there isn’t a one-size-fits-all solution to refinancing. Always take the time to do your homework, ask lots of questions and be deliberate about the process. Refinancing isn’t always the best answer for everyone, but in many cases, it is a powerful tool that can put you in better control of your home loan.
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