If you’re like the majority of homeowners in the U.S., you make your mortgage payment monthly, with the idea that someday you’ll own your home outright. As you continue to pay off your total balance, your home equity rises and you become one step closer to owning your home.
The downside is, mortgages, like any other type of loan or line of credit, come with interest. That means you pay the total balance owed, plus the annual interest rate applied to your mortgage loan. Additionally, your lender also assigns specific payment schedules and other terms to your loan, some of which you might find favorable, others not so much. That’s where refinancing comes in.
What does refinancing mean? In the most basic sense, refinancing is a way to alter your mortgage terms by replacing your old mortgage with a new one that is better fit for your financial situation. A lower interest rate, more manageable payment schedule, a shorter loan term, or consolidating multiple mortgages are just a few of the ways refinancing your mortgage can be beneficial.
In this post, we’ll answer some important questions, such as, “what does refinancing mean?”, “when is refinancing a good idea?”, and “what are the pros and cons of refinancing?”. For fast answers on the subject of refinancing, use the links below to navigate ahead. Or, read end-to-end for a complete overview.
What is Refinancing?
Pros and Cons of Refinancing
What is Refinancing?
Refinancing, also known as “ a refi”, is a way for borrowers to restructure their mortgage, auto, personal, or other loan type for more favorable terms. During the mortgage refinance process, you might make one or several of the following adjustments to your mortgage:
Secure a lower interest rate
Switch to a longer or shorter loan term
Change from an adjustable-rate mortgage to a fixed-rate mortgage
Cash-out some of the equity you’ve built in your home
Consolidate multiple mortgages into a single payment
Sounds pretty good, right? It can be. Anytime you’re dealing with changes to a loan, it’s a good idea to read the fine print, take a close look at the pros and cons, and really understand what happens when you refinance.
What happens when you refinance?
When you refinance a loan, whether it be a mortgage, auto, or some other line of credit, you’ll need to start by paying off your original loan, which you can do with the help of your refinanced one, after you’ve been approved for a new loan, of course. Once you have settled up with your original lender, you’ll be left to pay off your new loan according to the payment terms outlined by your new lender.
Am I eligible for a refinance?
Think back to when you applied for your original mortgage — you likely filled out an application, they checked your credit score and lending history, assessed the property, and proposed a mortgage option for you based on your financial profile.
The process for refinancing is essentially the same. The new lender will consider your credit score, lending history, the value of your home, how much you want to borrow, and your income and assets before approving you for a new mortgage. Ideally, your finances would be in a shinier state than when you got your first mortgage, and you’ll likely be asking to borrow less money, therefore, a refinanced mortgage could offer you a more agreeable interest rate or loan terms.
When it comes to determining eligibility, it’s ultimately up to your lender to decide. According to Rocket Mortgage, homeowners looking to refinance should consider the following criteria before applying:
How long you’ve owned the house: Generally, you must have the title for a minimum of six months.
Your credit score: Your lender is ultimately the one who decides what they consider to be a “creditworthy” score, but there are some basic benchmarks you can use to help. A good credit score is considered 670 and higher on the FICO scale and 660 and higher on the VantageScore model.
Your current home equity: The general rule of thumb is that homeowners should have a minimum of 20 percent home equity in order to qualify for a refinance. 20 percent is also the minimum equity needed if you want to get rid of your mortgage insurance.
Other debts: In addition to assessing your credit score and other financial metrics, lenders will typically consider your other debt obligations before approving you for a new loan. Take a look at how you’re managing your current debts before applying for a refinanced mortgage.
Closing costs: When you close on a loan, you’re typically responsible for paying closing costs, including, appraisal fees, title fees, credit check fees, and more. Before applying for a refinance, take a look at your monthly budget to determine whether or not you can afford to pay the closing costs on a new loan. ProTip: Use our budgeting calculator to help!
Financial details: Part of the loan application process involves lenders taking a look at the greater picture of your finances, such as, your income and assets, homeowner’s insurance, title insurance, etc. Make sure you have this information handy to make the refinance process more efficient if you choose to proceed.
Types of mortgage refinancing
Now that you know the basic refinance definition, it’s time to dig a little deeper. It probably comes as no surprise to you, but it’s important to know that there’s no one-size-fits-all refinance. There are several different types of mortgage refinancing that depend on the outcome that you’re looking for.
Rate-and-term refinancing: This type of refinance only adjusts the rate and/or term length of the loan.
Cash-out refinancing: Allows borrowers to adjust the mortgage length and/or term, plus, it increases the amount of the loan. Cash-out refinances are generally used when homeowners want to borrow extra money to make home improvements or other big purchases.
Cash-in refinancing: This is basically the opposite of a cash-out refinance. With cash-in refinancing, you’d pay down more of the principal balance to decrease your loan amount, generally in exchange for a lower mortgage rate.
Note: Another reason some homeowners choose to refinance is to consolidate their debts; instead of making mortgage payments to separate lenders for multiple mortgages, you could refinance and lump all of your mortgages into a single loan.
Pros and Cons of Refinancing
Like any financial decision you’ll make in your lifetime, it’s a good idea to consider the pros and cons of your decision. With that said, let’s take a look at some of the benefits and risks associated with refinancing.
The advantages of refinancing are simple: making your mortgage terms work better for you. That could mean getting a lower interest rate, which would translate to interest savings, you could secure more manageable monthly payments which might work better for your budget, or you could adjust your loan terms to better suit your lifestyle and financial situation.
Penalty fees: Some mortgage lenders impose penalty fees if you pay off your mortgage before the term ends. These fees vary by lender, but could potentially add up to thousands of dollars.
Closing costs: As we mentioned, there are several closing costs associated with refinancing. Keep these costs in mind as you weigh your options.
Longer loan length: Should you choose to extend the length of your loan term in favor of lower monthly payments or some other benefit, you’ll be stuck paying off your mortgage longer, which could be problematic for certain homeowners.
So far, we’ve answered “what is refinancing?”, “what happens when you refinance?”, “what are the types of refinancing?”, and “what are the pros and cons of refinancing?”. If you still have some lingering questions, we’re here to help by answering these refinancing FAQs.
Does refinancing hurt your credit?
One of the costs of refinancing is that it may impact your credit temporarily. When you apply for a loan, your lender will check your credit score , conducting something that’s called a hard credit inquiry. Hard credit inquiries can drop your credit score by a few points, but it won’t impact your score forever.
Bottom line: Refinancing can hurt your credit score temporarily. However, if the savings and benefits are worth it, a quick dip in your score probably isn’t something to be too concerned about, especially if your credit is in good standing.
Is refinancing a good idea?
It depends. Everyone’s financial situation is different, so it’s important to take a close look at your current situation, assess whether you’re eligible for refinancing, and really understand what it means to refinance.
When is refinancing worth it?
Refinancing may be worth your while if you can qualify for a lower interest rate or secure better loan terms than you started with. Some financial experts say that refinancing can be a good idea if you can lower your interest rate by at least two percent.
How do I calculate the break-even period?
Something to consider when you’re refinancing your mortgage is how long it will take you to reap the benefits of your new loan after considering closing costs. Use the worksheet below to help you anticipate your break-even period.
There are plenty of nuances to know about refinancing. As you consider whether it’s the right move for you, let’s recap some important points:
What does it mean to refinance?: Refinancing a loan is when you pay off your original loan and take out a new loan, ideally with more favorable loan terms like a lower interest rate or more manageable payment schedule.
When is it a good idea to refinance?: That depends on your unique financial situation. Refinancing can help you save money on interest and offer other important benefits, but it’s important to consider the benefits and risks in the context of your own finances.
To learn more about where your finances stand, check out the Mint app to set financial goals, glean insight into your financial health, and more.
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Mortgage rates are at historic lows, and while there are no hidden fees that accompany a low APR, there are a couple trade-offs to keep in mind.
You may find a lower rate with an adjustable-rate mortgage (ARM) than with a fixed-rate mortgage, but the ARM rate could increase when the introductory rate period ends.
If your down payment is under 20% of the home value, you’ll have to pay private mortgage insurance (PMI), which could add hundreds or thousands of dollars to your annual payments.
You probably don’t need to rush to buy a home with a low rate, because mortgage APRs will likely stay low in 2021.
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Mortgage rates are at historic lows, so it could be a good time to buy a home. But you may be wondering whether there is a downside to low rates.
In short — nope, there’s no catch. A low APR can save you thousands over the life of your loan.See the rest of the story at Business Insider
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The June nonfarm payrolls report will be released Thursday, July 2, from the Labor Department.
Economists surveyed by Bloomberg expect that the US economy added 3 million payrolls in June and that the employment rate declined to 12.5%.
If the report is in line with expectations, it will be the second month of jobs added since the US lost a record 20.5 million payrolls in April due to the coronavirus pandemic.
Visit Business Insider’s homepage for more stories.
Businesses in June likely continued to hire as most states across the US went forward with reopening plans following coronavirus-pandemic lockdowns earlier in the year.
Economists surveyed by Bloomberg expect that the US economy added 3 million jobs in June after adding 2.5 million in May, and that the unemployment rate declined to 12.5%. The report is due Thursday, instead of the usual first Friday of the month, because of the Independence Day holiday. See the rest of the story at Business Insider
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A key labor-market ratio has tumbled near record lows — and Deutsche Bank’s top economist says the US has to create a whopping 30 million jobs to reach a new all-time highJob losses are 4 times worse for the lowest-paid workers so far in the coronavirus pandemic, study showsUS weekly jobless claims hit 1.5 million, higher than economist forecasts
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A mortgage is a loan given by banks (or other financial institutions) to those who plan to purchase a home. There are many types of mortgage loans available, depending on your financial health and how long you want to pay the loan back. The amount you’re allowed to borrow — as well as the interest rate — can vary depending on your credit history and the market.
It’s important to know all the mortgage options you have available, including key terms you’re bound to hear when approaching potential lenders. You’ll be making payments on this home for the next 15 to 30 years, after all, so understanding what you’re signing is crucial to ensure you’re making the best decision for your future.
After you’ve saved enough for a down payment, read up on the next steps in the process to help boost your financial health. Below, we’ve put together a guide on what a mortgage is, including the ins and outs of the type of loans you’ll get to choose from.
Table of Contents:
How Does a Mortgage Work?
The Main Parts of a Mortgage
Types of Mortgages
How Does a Mortgage Work?
Under a mortgage agreement, the bank, credit union, or other lender lets the customer borrow money to purchase a home in exchange for monthly payments with a tacked on interest rate. The “mortgage” itself refers to the lender’s ability to take back the home if the borrower misses payments, also known as a collateral loan. While the buyers technically own the home, the lender has the power to cash in on the collateral of the home if the buyer defaults on payments.
The two main parties involved in a mortgage loan are the lender and the borrower. A lender is a bank or other financial company that lends out money to customers to help them make larger purchases such as a car or home. A borrower refers to the individual(s) that will be borrowing money from the lender and paying it back over a set period of time.
The Main Parts of a Mortgage
There are various factors and real estate terms that get thrown around when discussing a mortgage. Some of the most important sections within a mortgage loan are the principal, interest, insurance, the length of the loan and taxes. Below, we break down the unique terms you might come across as well as the mortgage loan basics.
The principal is the dollar amount owed on your mortgage, usually noted in both the total amount as well as monthly payments on your loan. For example, if the house is for sale for $230,000, and you put down 20 percent ($46,000), you would need to take out a loan for the remaining principal amount of $184,000.
The interest rate is the percentage that you owe the lender for borrowing the money, on top of the original principal amount. Mortgage interest rates currently average around 4 percent, but can reach as low as 2 percent on shorter loans or for borrowers with a good credit score and robust credit history. You’ll often see interest rates marked on loans as APR (annual percentage rate) which adds in other borrowing costs outside of the principal interest. As this rate is required on all loans, you can compare APR’s on multiple mortgage offers to make sure you are taking advantage of the best deal.
You can help get this interest rate lowered by taking advantage of mortgage points. This process allows you to make upfront payments to your lender for a reduced interest rate that spans the life of your mortgage loan. To get one mortgage point, you have to pay 1 percent of your total mortgage up front. And while costly, these points can help save you money over the length of your loan by lowering your monthly interest rate.
Typically, there is a portion of the loan agreement that discusses mortgage loan or private mortgage insurance, as the lender will want to be financially protected in case you aren’t able to make your payments. This is more common for borrowers with low credit scores or those who weren’t able to put down at least 20 percent of the cost upfront.
In some states, there are taxes you need to be aware of when moving forward with a mortgage loan. Property taxes are set by your local government (and sometimes your state government as well), and are grouped along with your hazard insurance and can be escrowed.
A mortgage recording tax is a one-time fee charged in all 50 states. You can expect to see additional charges (on top of the recording tax) during closing in the following states: Alabama, Florida, Kansas, Minnesota, New York, Oklahoma, and Tennessee.
A promissory note is a written agreement of payment between two parties. It’s the legal document that you sign when getting a mortgage loan, and it includes how much you will pay the lender each month and for how long. It also documents the next steps if the borrower isn’t able to pay, which is also known as defaulting on a loan.
Mortgage amortization is the process of splitting up the principal and interest amounts owed into equal payments over the length of your loan. While the amount of money that goes towards your interest and principal varies over the length of your loan, this process ensures that your overall monthly payment is the same. For example, at the beginning of your loan, most of your monthly payments will go towards interest. However, over time you will owe less interest and the majority of your monthly payment will go towards the principal.
Traditionally, escrow refers to the securing of the transaction when buying a home. The buyer transfers money to an escrow company while the homeowner does the same with their property. By taking each asset to a reliable third party, the transaction is secured while final inspections are made.
When getting a mortgage from a lender, an escrow account refers to the amount of money your lender takes from your monthly payments to pay for home insurance and other taxes on your behalf (this payment is not always required). In addition to taking money each month, most lenders will require upfront payment to cover several months (sometimes as many as six months) before they will move forward with the mortgage loan.
Types of Mortgages
There are a few options to consider when looking at the type and length of mortgage loan to move forward with. There are 15 and 30-year mortgages as well and fixed and adjustable interest rates to consider. Below, we break down the types of mortgages to help you make the best decision before signing a loan.
A fixed-rate mortgage is a mortgage loan whose interest rate is permanent throughout the entirety of the loan (no matter if it’s a 10- or 30-year loan). While fixed-rate mortgages mean there won’t be a spike in interest if market rates increase, it also means that borrowers must refinance to take advantage of lower rates. Fixed rate mortgages are the least risky of all loans and a 30-year fixed mortgage is the most popular loan type used.
Adjustable-rate mortgages (ARM), also called floating or variable rate mortgages, have interest rates that will fluctuate according to an index (such as the LIBOR) lenders and their margin rate. Typically, these rates will change yearly from the time of signing. Often, ARMs have annual and lifetime caps, meaning the change can’t be too drastic from year to year.
ARMs are structured with an initial rate set for a predetermined amount of time, ranging from one to ten years. Generally, the longer the time frame, the higher your short-term fixed interest rate will be. After this time frame has passed, the rate will change each year. While this allows you to take advantage of a lower interest rate in the beginning of your mortgage loan, there is more risk involved later on when the interest rate begins to fluctuate.
Should I Get a 15- or 30-Year Mortgage Term?
Understanding your financial health and plans for the future can help you determine what length of loan would work best for you. While there are many different loan lengths, a 15- or 30-year mortgage loan is most common.
A 15-year loan allows you to pay off your home sooner with higher monthly payments, while 30-year loans offer lower payments for a longer period of time. The downside to 30-year loans is that you’ll be paying significantly more interest than a 15-year loan, even though the overall payment each month is lower.
The flexibility of mortgage types, interest rates, and lengths allows people of all financial backgrounds to find the mortgage loan right for them. However, understanding the details of your legal agreement can help ensure that you make the best and most realistic decision for your future. After all, proper financial planning doesn’t just include monthly payments. It also includes saving up for repairs, accidents, and managing your expenses. But by keeping all these factors in mind, you can set yourself and your family up for success for years to come.
Sources: Federal Trade Commission
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