Choosing a Reason to Refinance
It is important to establish goals before deciding if a refinance is the right decision for your situation. There are a few reasons that most people choose to refinance a mortgage. The most common are to take cash out, lower payment (either by removing Mortgage Insurance or lowering interest), or shortening the term. We will discuss these in a little more depth.
Cash Out Refinance
Owning a home is an investment and similar to other investments, you can liquidate (or pull money out) the investment. In terms of mortgages, liquidation can come in the form of a cash-out refinance. With a cash-out refinance you basically refinance your mortgage at a higher loan amount than what is currently owed. The difference between the loan amount and the mortgage payoff, minus closing costs, is paid to you. As an additional benefit, these proceeds are tax-free.
What you do with the money from the cash-out refinance is up to you. There are no restrictions. You can use the money to pay down high interest credit cards, or you can take cash out to finance home improvements, education, or whatever else life has thrown at you. Mortgages typically have a lower interest rate than other types of debts, so a cash-out refinance can be a great way to consolidate or pay off debt. Also, keep in mind that mortgage interest is tax-deductible where other debt interest is not.
You may be able to take cash from your home if you have paid long enough to have built enough equity. If your house has gained in value, you may also be able to do a cash-out refinance despite not having paid much in equity; the higher value on the your home means that the lender can give you more to finance it.
Get a Lower Payment
As mentioned above, another popular reason to refinance your mortgage is to lower your payment. A lower mortgage payment means more money in your pocket. There are a few ways that you can lower your mortgage payment.
The first, and most obvious, way to lower your mortgage payment is to refinance at a lower interest rate. If the current rates are lower than what you are currently paying, give us a call and see what the new interest rate could be. By lowering your interest rate, you lower the interest portion of your payment and stand to save quite a bit while the loan matures.
Another reason that many refinance, is to remove the mortgage insurance from their loan. Mortgage insurance is a monthly fee that is paid to protect the lender in the event that you default on your loan. For Conventional Loans, mortgage insurance is required when you put down less than 20%. Other types of loans, such as FHA, require mortgage insurance regardless of the loan-to-value (LTV). Refinancing can be a way to stop paying mortgage insurance and save hundreds of dollars each month.
Lengthening your loan term can also lower your mortgage payment. For example if you have been paying on your 30-year mortgage for 10 years, you can refinance for another 30-year mortgage which would re-amortize your current principle over 30 years instead of the 20 that you have left on you current loan. When you spread the loan out, the principle payment decreases, and can be a way to lower your mortgage payment.
Shorten Mortgage Term
Shortening a mortgage term will save you in the long run on interest accrued through the life of the loan. In addition, often time, shortening the loan term will result in reduction in the interest rate on the loan.
Let’s break this into an actual scenario so that you can see how it works. If you have a loan amount for $200,000, and received a 30-year fixed rate or 3.5%, you would pay approximately $123,000 in interest over the life of the loan. If you paid the same loan in 15 years, you would only pay $57,000 in interest. That is a difference of $66,000. This is not to mention that you often see lower rates for the lower term loans and that was not factored into this figure.
It is important to note that shortening the term will increase the monthly principle payment, and therefore your monthly payment will be higher. However, less of your monthly payment will go to interest and more will be applied to paying down the balance of your loan.
How long should I wait before refinancing my home?
In most cases, you will want to wait at least a year before refinancing your home in order to get significant benefits from refinancing. There are seasoning requirements that are set out by the CFPB that require that you make at least 6 payments and that the current loan must be older than 210 days old.
Things You Need to Evaluate Before Refinancing
Once you have established your goals, or ultimately what you wish to achieve from the refinance, you will want to take a look at your overall financial situation to make sure that you can get the best result from your refinance. There are four key things to take a look at: your credit score (FICO), your monthly mortgage payment, the value of your home, and your debt-to-income (DTI) ratio.
Your Credit Score (FICO)
There are many online resources to allow you to see your credit score. The one key thing to look at is to make sure that you are viewing your FICO 5, 4, 2 score which is what is used in the mortgage industry to qualify your loan. Absent of the FICO 5, 4, 2, you can look at more current versions of FICO such as FICO 8 or FICO 9. There are many people that are relying on Credit Karma and their use of VantageScore. While this gives you a pretty good idea of your credit situation the algorithms are different and the score produced during your application will differ.
Your Monthly Mortgage Payment
Knowing your monthly mortgage payment will allow you to properly budget so that you can adequately assess your options. If you are thinking of doing a cash-out refinance or shortening your term, it would be good to know how your current payment fits into your budget and how much excess can be allotted to the new mortgage payment.
The Value of Your Home
Before refinancing your home, you should do some research to see what it worth. Homewise Financial can assist you in this by performing an assessment on your house and determine an approximate value. Give us a call to discuss this. Our lenders can’t lend more than the house is worth, so if an appraisal comes back lower than expected it can influence your ability to refinance. This is especially true if you are trying to do a cash-out refinance or removed mortgage insurance.
Your Debt-to-Income (DTI) Ratio
The final consideration to consider is your DTI. DTI is calculated by adding all of your monthly debts and dividing it by your income. DTI is one way that lenders determine your ability to repay your loan.
An example of DTI: Let’s say you are paying $1,000 for your mortgage and $500 on the rest of your debts (credit cards, auto loans, etc.), your monthly debts would total $1,500. If your gross monthly income is $4,500, your DTI would be 33%.