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Refi 101

March 11, 2021

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Refi 101

Maybe you heard that a friend is refinancing their home, or perhaps a targeted Instagram ad brought the idea to your mind. Either way, you’re thinking about refinancing, but you’re not sure it’s for you. We’re here to help. It’s a big decision and one to made carefully. We can outline some terms to help you understand everything and some questions to consider when thinking about refinancing. 

Types of refinancing

There are three ways to refinance - rate and term refinance, cash-in refinance, and cash-out refinance. Before deciding to refinance, make sure to educate yourself on all three types to see which will work best for your current situation. 

Current mortgage rates

Mortgage rates are in a constant flux state, so it’s important to strike while the iron is hot. Rates rise and fall with the economy and inflation. So, unless the current mortgage rates are lower than what you’re already paying on your loan, refinancing isn’t the right move. You wouldn’t want to end up paying more than you already do!

Know your home’s equity

Let’s talk about equity. Home equity is the market value of your home minus any outstanding balances on the property. In other words, home equity is how much of your house you own. Equity is also affected by any home improvements you’ve made on the house. Home renovations would more than likely raise your equity as well. If you hope to tap into this equity and follow through with a cash-out refinance, make sure to know where your equity stands - this is going to tell you if you qualify and how much you can take out.

What is your debt-to-income ratio?

Before refinancing, it’s a good idea to become familiar with your debt-to-income ratio.  Are you noticing a trend here? So much of the refinancing process boils down to your financial situation. Your debt-to-income ratio is the percentage of your monthly gross income that goes toward paying off your debts. It is important to know this before refinancing because if you have gained more debt since taking on your existing mortgage, you may find it more challenging to move forward with the refinancing process.  

Know your credit score

Similar to your equity, it is essential to know your credit score when deciding to refinance. Yes, the current mortgage rates can give you a general idea of the market and if you can save; however, your actual rate will be the ultimate deciding factor.

When it comes to your credit score, the key factors at play are your credit, your existing debt, and your income. However, remember that your credit score isn’t etched in stone. You can always be working to improve it. Most lenders look for a credit score of above 560 to qualify for a refinance. If you aren’t there yet, don’t fret! This doesn’t mean you are stuck with your current loan rate; it just means you need to work on raising your credit score first before we can take the next steps into refinancing.

Have you hit your break-even point?

Breaking even means your money spent and money saved have equaled out. Let’s say refinancing will cost you $3,000, and you will be saving $300 per month. It’s going to take you ten months to break-even and catch up to your costs. Once you break-even, you can truly reap the benefits of refinancing your mortgage for a lower interest rate.

Breaking even matters because depending on how long you intend to live in your home, you may never breakeven after refinancing. In the above example, it’ll take ten months to break even. So, if you’re looking to sell your house within the next year, refinancing doesn’t make sense. However, if this situation applies to you and you intend to live in your home for the foreseeable future, you will have a delightful reward to reap.

Understanding the relationship between your break-even point and life goals is invaluable when considering the option to refinance. A broker can help you figure this out if you need a hand!

Mortgage insurance: Do you have it?

When buying your home initially, if you put down less than 20%, there is a chance you are paying private mortgage insurance. For reference, private mortgage insurance (PMI) is a type of insurance that protects lenders from a borrower not paying back their loan. If this is the case, this tip is not for you. Carry on to the next one!

However, if you got a loan from the government, there is a chance you are paying some other form of mortgage insurance. Due to this, you may want to check if your home has decreased in value since purchase. If this is the case for you, don’t be alarmed if you are required to start paying a PMI for the first time. A lender can easily find out if refinancing will cause you to have to pay a PMI and even let you know how much this will add to your costs per month.

Don’t forget the closing costs!

Remember, the process of refinancing isn’t free—the cost of doing so can vary between 2-6% of your loan. Depending on your loan price, this could get pretty pricey pretty quickly. It’s essential to keep these costs in mind when considering your options. There are a few ways to lessen the load of a new loan, though, so let’s talk about it. Some borrowers may be able to lower costs or even transfer them over to your new loan. This transfer would mean paying interest on them for the life of your new loan, but for some, that’s the only feasible option. There’s nothing wrong with that choice, though. Everyone’s financial situation is different, and these options are there to accommodate that.  

Determine your new mortgage term.

Arguably one of the most important steps in refinancing is what your new mortgage term will be. You can typically change your term to a 10-year, 15-year, or 30-year mortgage.  Keep in mind, getting a shorter-term mortgage will most likely increase your monthly payments.  While some people can afford this, others may not be able to do so.

The flip side would be to increase your mortgage term, resulting in lower monthly payments but keep in mind; you’ll also be paying more interest overall. It’s best to make a budget plan that works for you and choose which options fit best into that budget, instead of the other way around.

At the end of the day, it all comes down to your situation and lifestyle. Refinancing is a big deal, and you should treat it as such—weigh all your options, make a budget, and ask for help. Don’t be afraid of refinancing but know what you’d be getting yourself into beforehand. Always know that mortgage professionals are here to help you answer any questions you may have along the way.

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