Refinancing your home is a great way to reduce your monthly mortgage payments, pay off your home faster, and even consolidate debt. There are a lot of factors to consider before you move forward with the refinance though, so keep reading to learn more about what it means!
What is a Mortgage Refinance?
When you refinance your mortgage, you are essentially breaking your current mortgage and starting a new one on the same home. You may work with the lender that holds your existing mortgage or a new one, depending on the rates and terms offered.
Most people will refinance their loans to access lower interest rates, cash in their home equity for renovations or debt consolidation, or to reduce their monthly payments.
How Much Does It Cost to Refinance Your Mortgage
Even though refinancing involves keeping your existing home, a new loan must be established, and there are costs associated with this.
Regardless of your reasons for refinancing, you will likely incur legal costs to change the financing on the title. Some lenders may be willing to cover some or all of this cost if the mortgage is over $200,000.
Since you are breaking your existing mortgage before the loan term has been completed, you will also face a prepayment penalty. If your current loan has a fixed mortgage rate, the penalty will be the greater of the interest rate differential payment (IRD) or three months of interest. On variable mortgages, the cost to break your mortgage is three months of interest payments.
The IRD considers a few different factors, including the amount you are paying early and the difference between your current interest rate and the one that the lender can charge today when reissuing the mortgage.
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What Are The Benefits of Refinancing Your Mortgage?
There are many benefits to refinancing your mortgage, including accessing the equity in your home, obtaining lower interest rates, and consolidating debts.
Access Home Equity
If your home is worth more than the value of your mortgage, you may be able to refinance it and access that equity. Typically, you can access up to 80% of your home’s value minus any outstanding debt. This money can be used for home renovations, paying for your children's education, or other investment opportunities. Although you can also access this equity using a home equity line of credit or a blended mortgage, often refinancing will provide you with the best rates.
Lower Your Interest Rate
One of the most popular reasons that people want to refinance their loans is to lower their interest rate. If mortgage rates have dropped since you established your loan, reducing the interest rate will save you quite a bit of money over time.
It is important to use a mortgage refinance calculator to determine what rates you might be eligible for based on your income and credit score. Similarly, the money that you save must be worth paying the cost of refinancing and the prepayment penalties.
Another benefit of refinancing your mortgage is that you can use the equity in your home to consolidate debts. Car loans, personal lines of credit, and credit card bills usually charge much higher interest rates than a mortgage, so consolidating this debt through a refinance will help you not only to pay them off but also allow you to save money over time.
Pay off Your Home Sooner
If you are not looking to lower your monthly mortgage payments, you may be able to refinance your home and pay it off sooner. Refinancing to a shorter loan term may increase the amount you owe each month, but you will save money on interest and have total ownership of your home much faster.
How Do You Refinance Your Mortgage?
Once you've gone through mortgage refinance calculators or worked with a broker - and if the numbers make sense - you can begin to move forward with the refinance.
The first option is to break your existing mortgage and obtain a new one. Generally, this will require terminating your loan with your current lender and working with the new one. This will also require you to pay applicable prepayment penalties and loan origination fees.
You can also refinance your mortgage by adding a home equity line of credit. This option gives you access to your equity, but at your discretion. It's almost like a credit card that is secured by your home. Interest rates are much lower than they would be on credit cards, but you will be responsible for monthly payments on the outstanding balance.
Blending and extending your existing mortgage are also refinancing options. Blending involves working with a mortgage lender to obtain a blended rate, which mixes your current mortgage rate plus additional borrowed funds at current rates. These rates tend to be higher, though, so be sure that you work with a broker to find the best option for you.
All of these options will require applying for a refinance, running your credit score, and paying the required fees.
When Should You Move Forward with a Refinance?
As you can see, there are many benefits to refinancing your mortgage, but there are also several risks and costs that must be considered.
You should move forward with your refinance if you've built up enough equity in your property, want to reduce your monthly mortgage payments, or need to change the interest rate on the loan. Be sure that you still have a good payment record and credit score since need to qualify for the refinance.
How Does Refinancing Impact My Credit?
Since the new lender will have to check your credit when you refinance, your score might take a hit. The credit inquiry will be the largest contributor to changes in your credit score, but this will not significantly impact your rating.
You will have a shopping period of 45 days where you can incur several hard inquiries as part of your refinance process - but they will only count as one.
Questions for Your Lender
As you consider refinancing your mortgage, there are several questions that you should ask your lender including the following:
- What interest rates will I qualify for?
- What are the prepayment penalties associated with my existing loan?
- Are there any other loan origination fees or applicable charges?
- How will my monthly payments change if I refinance?
When you shop for lenders, it is necessary to thoroughly understand their process so that you can make the best refinance decision possible!
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