Mortgage Refinance: Does It Make Sense To Refinance?
After purchasing your home with a mortgage, the most significant decision that you may have to make is whether to refinance the mortgage loan or not. Usually, when interest rates decrease even slightly, lenders and mortgage brokers will rush to encourage homeowners to refinance.
But is it, in fact, wise to refinance at the slightest drop in interest rates? We here at Mortgage Right want to help you get the best answer to that question.
What Is Refinance?
A mortgage refinance refers to replacing your existing home loan with a new one. The new mortgage typically comes with different terms and interest rates. Homeowners choose to refinance their mortgages for various reasons.
- Obtaining better lending terms
- Switching from a fixed-rate mortgage (FRM) to an adjustable-rate mortgage (ARM) or vice-versa
- Lower interest rates charged on the mortgage
- Tap into a home’s equity and get some cash to spend, or
- Adjust the loan’s duration. You can either choose to increase or to decrease the repayment period.
Your Home Loan Refinance Options
Knowing why you are refinancing is crucial because it will help you determine the type of refinance that suits you best and when to refinance. Here are the various options from which you can choose a suitable one:
If you currently hold an FRM, you can refinance it to an ARM. In the short term, an ARM is much more affordable than an FRM because ARMs usually attract lower interest rates within their first years (5 to 10 years). This option makes sense if you are planning to sell the home sooner rather than later, and are therefore less concerned about future higher rates.
In case you are planning to stay in the home for a long time then refinancing to an FRM mortgage makes more sense. The reason behind that is simple; when you refinance to an FRM, the term of your loan will increase. It will reset to the original term or another payback period that is longer than what you currently have.
This option involves refinancing to lower the interest rate charged on your home loan. You can also negotiate for better terms and adjust the duration of the loan (by either increasing or decreasing the repayment period). It is called ‘streamline’ because the process doesn’t come with the plenty of legwork and paperwork that is typical with the application of a mortgage loan. In short, a streamline refinance is usually completed in very few steps and within a short time.
While the speedy processing is a huge advantage, it is not the primary reason why homeowners choose the streamline refinance option. The main reason is to lower interest rates. When market rates drop below what you are currently being charged, you can select this refinance option to reduce your rate and match it with the current interest rates.
For example, if you are currently paying 5.36% but the market rates for the same mortgage loan are 4.43%, you can refinance and lower your rate from 5.36% to 4.43%. The lower rate means your monthly payments also reduce, and that puts you in a prime position to save some money.
Cash out refinance
While under streamline refinance you only get to lower interest rates and perhaps change the terms and duration of your loan, the cash out refinance option allows you to do all that and get some money in the process. What happens is that the lender will give you more money that you owe, so basically, the new loan will be a larger amount than your current loan. That extra amount is for you to use as you please.
Many homeowners spend the money on home repairs and upgrades, consolidating debts, managing emergency needs like medical bills, making investments, or paying for education.
As a rule of thumb, you can only do a cash out refi if:
- Your new rate will be substantially lower than your current rate,
- You don’t plan to move or sell the home in the near future, and
- You can reduce the term of the home loan.
Overall, a cash out refinance makes sense if you are in dire need of emergency cash. Otherwise, if you only want to lower your rate and adjust the term, you can simply go for a streamline refi instead.
Cash out refinance is available for conventional, FHA, USDA and VA loans. That said, many lenders are usually reluctant to offer cash out refinance for conventional home loans.
Home Affordable Refinance Program (HARP)
This is a special type of home loan refinance, one reserved for homeowners with underwater mortgages. Your mortgage is said to be underwater if its remaining balance is higher than the market value of the home that you purchased using the loan.
As an example, assume you purchase a property worth $200,000 using a down payment of $50,000 and mortgage loan of $150,000. Under normal circumstances, homes usually appreciate in value, and their equity will be higher than the outstanding mortgage. But let’s say the real estate market performs poorly, and the home loses value. Assume it is now valued at $142,000; which is $8,000 less than the outstanding mortgage. In that case, it will be underwater by $8,000.
If your home loan is underwater, you cannot refinance it using the usual refinance options because the lender will make a loss. You also can’t sell the property, unless you are willing to take the loss or top up the ‘underwater’ amount using cash – which is essentially a loss. Luckily you can refinance using HARP.
So many mortgages went underwater following the subprime mortgage crisis of 2008. The real estate market collapsed, forcing homes to lose value at an unprecedented rate. That prompted the government to introduce the HARP in 2009. Under the program, eligible homeowners with underwater mortgages are allowed to refinance and revalue their home’s equities.
The Benefits of Refinance
There’s no question refinancing a home loan comes with tons of benefits. That’s especially true if you choose the right type of refinance. We’ve just put those benefits in the sections above. How about we pinpoint the main advantages of a mortgage refinance so that you see why it’s worth your consideration.
A refinance allows you to:
- Lower interest rate and monthly payments
- Adjust the term of the mortgage loan
- Switch from ARM to FRM or vice-versa
- Tap into your home’s equity and get emergency cash
- Correct an underwater mortgage
Another noteworthy point to keep in mind is that lenders do have eligibility standards for mortgage refinancing. The requirements usually vary depending on the type of refinance, but generally, these factors will be considered:
Whether your new rate will be lower
- The equity in your home
- Your credit score
- Your debt-to-income ratio
- Your ability to pay refinance costs (in case the lender wants an upfront payment)
The Bottom Line
With careful consideration, refinancing can help you pay a lot less on your mortgage and save more. Depending on the terms of your loan, you can even use the money you save after refinancing to pay off the mortgage earlier.
However, as we have mentioned already, it’s not always the right time to refinance. Only make it a viable course of action if the drop in interest rates can translate to lower monthly payments, without increasing the total amount payable over the term of the loan.
For a better picture of whether you stand to gain from a refinance, contact Mortgage Right and we will give you a comprehensive cost-benefit analysis with the latest interest rates. We will also inform you the refinance options that are best for you.