Approximately two-thirds of all homeowners in the U.S. have a mortgage on their home. Many of these individuals, though, could benefit from refinancing their current home loans. Are you considering refinancing your mortgage? You aren’t alone. The Mortgage Bankers Association reports that 62.4% of all mortgage applications were to refinance existing home loans. There are several benefits to refinancing a mortgage. The most common, however, is to save money. Saving money is the number one reason people turn to mortgage refinancing, and a refi can help you save money in several ways.
The Definition of Refinancing
Refinancing a mortgage loan means that you replace your existing mortgage with a new one. The new mortgage loan pays off your current mortgage in full, and you have a new lender with different terms. Once you complete the mortgage refinance, you no longer have any connections or obligations to your previous lender. Instead, you have responsibilities only to your new lender. Here are some things to consider when you are refinancing your mortgage.
1. To Get a Lower Interest Rate
As mentioned, most people refinance to save money. One way you save money through this is by getting a lower interest rate. The rate you pay on your mortgage affects your monthly payments and the amount of interest you pay over the life of the mortgage loan. If you get a lower interest rate, you pay less interest. The result of this is that you will have lower monthly payments. Mortgage interest rates change frequently, so homeowners can often save money by refinancing when APRs drop. You can check out refinance rates if you're interested in seeing if they are lower than the current rate you have on your mortgage.
The cost savings on refinancing are directly proportional to the amount of the principal balance. A consumer that purchased a $300,000 home with a 20% down payment would have a $240,000 principal balance at the onset of the loan. If they immediately refinanced to a rate 1.5% lower than their current contract, then they could save $3,600 a year. This averages out to be $200 less per month. You should also know that you can get a lower rate if you now have a much higher credit score than you had when you took your original mortgage.
2. Lower Your Mortgage Payment
One of the most valuable benefits of refinancing is that it can lower your monthly mortgage payment, providing you more wiggle room in your monthly budget. When you refinance, you have the option of resetting your loan for a new term. Assuming you're not cashing out the positive equity, your total balance will be much lower depending on how many years you've been paying it down. This lower total plus a lower interest rate over a renewed term can drastically lower your monthly payments. Additionally, refinancing your mortgage may allow you to cancel your mortgage insurance from the original loan.
3. To Remove Your Private Mortgage Insurance (PMI)
Refinancing a mortgage to get rid of the PMI offers another way to save money on your home loan. PMI payments can be a burden to many homeowners. Refinancing your mortgage can help to expedite the time it takes for the removal of PMI. An added benefit of mortgage refinancing is to reduce or remove your private mortgage insurance (PMI). If you currently pay PMI on your loan, it is because you borrowed more than 80 percent of the home's value when you took your original mortgage. You might not have to pay PMI anymore if you reduce the principal balance to 80% of the property value. If you have more than 20 percent equity in the house today, you can eliminate the PMI. While you can eliminate it through your existing lender without refinancing, it is often easier to eradicate it by refinancing on a new home loan with a lower rate. Mortgage insurance on FHA loans can differ from PMI on conventional loans. Refinancing your mortgage loan from FHA to Conventional can also have MI benefits.
4. To Reduce the Length of the Loan
Should you refinance your home to pay it off sooner? If paying your mortgage off quickly is a major priority for you, then refinancing can help. While most mortgages don't have penalties for early payoffs, homeowners have a hard time applying extra money into their mortgage each month. You could refinance to a 15 or 20-year mortgage to reduce your term. Refinancing like this could instantly cut five to ten years off your loan. It would also reduce the interest you pay during the lifetime of the loan. However, if you refinance your loan for a shorter term, it will raise your monthly mandatory payment. This will save you thousands of dollars over time. For example, a $200,000 loan with a 3.5% interest rate over 30 years will cost you $323,000 over the life of the loan. However, if the term of the loan was only 20 years at the same interest rate, it would only cost you $278,000. You would be saving $45,000 in interest alone.
5. Get a Cash Out Home Equity Loan
Other people choose to refinance to take cash from the equity they’ve built up over time. Almost 80% of American workers live paycheck to paycheck. As such, few have the money to make big investments, like starting a business or putting money down on an RV. In some cases, refinancing your house can be a convenient way to get the cash you need. While we should warn you that this will increase your total debt amount, only you and your circumstances can dictate whether or not it's worth the risk. If you choose this home equity loan option, your new loan will have a higher balance than your current loan, but you could have an easy way to get cash out for any purpose you have.
6. Consolidate Debt
The average American has roughly $38,000 in personal debt, which does not include mortgages. One of the biggest benefits of a debt consolidation refinance loan is that it can greatly improve your financial situation. If you have a decent amount of positive equity in your home, refinancing your mortgage can be used to reduce your monthly expenses. For example, if your home is currently worth $225,000 but you only owe $180,000, you could use the majority of the equity ($45,000) to absolve debts with high-interest rates. Your new mortgage could consolidate things like credit cards and personal loans. Under your new mortgage, your interest rate for those debts will be closer to 3%, rather than the 16% or higher that is common with credit cards.
7. Eliminate IRS Tax Liens or Past Due Property Taxes
The IRS is imposing more underpayment penalties on taxpayers than ever. The most recent figures show that 10 million people are billed for underpayments every year. State and local tax authorities also place a burden on citizens that fall behind on their tax payments. Interest rates and penalties on tax underpayments can be substantial. You can often save money by taking out a home equity loan to pay them off. Your mortgage interest rate will usually be lower than the rate charged by the IRS or your local tax authority. The opportunity cost of restructuring your debt with a mortgage refinance will be lower if you refinance your property at a lower interest-rate.
8. Combine a 1st and 2nd Mortgage
Do you have more than one mortgage lien on your property? You might be able to consolidate them by refinancing two mortgage loans into one mortgage loan. Do this can reduce your monthly mortgage payment and lower your interest rate.
9. Finance Home Renovation Projects
One of the biggest homeownership advantages is being able to customize your home however you want. You can improve your home, increase your comfort and luxury, and add to its equity in the process. However, some home renovation projects are expensive and most people can't afford them out of pocket. Refinancing your home to raise money for your projects isn't a bad idea. Your investment will add value to the home and improve your living situation.
10. Buy Out an Ex-Spouse After a Divorce
We can't always predict the way things are going to turn out in life. Sometimes, we're pleasantly surprised by new relationships. Other times, we suffer through life changes like divorce. In either case, it may be necessary to refinance your home to add or remove a person from the mortgage. One of the more practical benefits of refinancing is that it allows you to change fundamental aspects of the loan, such as co-signers. Dividing property is one of the biggest headaches during a divorce. If one spouse gets to keep the property, then they will have to buy out the equity of the other. Refinancing is usually necessary under the divorce decree.
11. Convert an Adjustable Rate Mortgage (ARM) to a Fixed Rate Mortgage
Additionally, you may want to consider refinancing if you have an adjustable-rate mortgage. ARMs can be easier to obtain and start with a fixed rate for a short period of time. However, after the fixed-rate period, your rate could fluctuate yearly, or even monthly depending on your contract. The behavior of fluctuation depends on the current market. If you want to change to a fixed-rate loan, refinancing is a good way to do it.
Refinancing Can be a Smart Option
You may decide to refinance for one of these reasons or all of them. Whether you're consolidating debt or simply lowering your monthly payments, refinancing your home could improve your credit score. Your debt to income ratio is an important factor in determining your credit rating. The debt to income ratio is the amount you pay toward debt each month versus your income. When you consolidate debt, your monthly mortgage payment will increase. However, it will likely be far lower than when you were paying the debts off individually. Alternatively, if you refinanced just to lower your monthly mortgage payment, it will still be reflected positively in your credit report.
There are many reasons homeowners choose to refinance their mortgages. If you're thinking about refinancing your mortgage, we encourage you to make sure you've thought about the pros and cons. It is important to work with the right mortgage company to get the best possible rates. If you're ready to refinance, check current mortgage rates, or request a loan summary without impacting your credit.
FURTHER READING:
Refinance options such as an IRRRL or a Non-Credit Qualifying Streamline do not require an appraisal. However, it is highly likely that a traditional Fannie Mae or Freddie Mac refinance will allow for an appraisal waiver. Save yourself over $500 by asking your licensed loan officer how you can increase your chances for an appraisal waiver.
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