Planning to Refinance Your Mortgage? 5 Questions You Should Ask

Porch of a nice home

Guest Post by Lyle Solomon

In theory, refinancing your mortgage is brilliant, especially now that interest rates are declining. Still, it may only sometimes be feasible or even desirable for some homeowners.

To assess whether a refinance makes financial sense, homeowners should ask the following questions before making a decision.

How can you qualify for refinancing?

You must satisfy the requirements set forth by each lender to be eligible for a refinance. Find out from your lender what requirements you must fulfill in the following areas:

Credit score

Your credit score is a three-digit figure showing your history of handling credit and loans. You should be able to determine from your lender what credit score is required to be eligible for each loan form.

DTI (debt-to-income) ratio

Your DTI, expressed as a percentage, lets your lender know how much of your income is used for recurring, regular spending. If your DTI is high, you risk having fewer savings and missing mortgage payments. Your lender ought to be able to explain how to calculate your DTI and provide you with the maximum DTI required for each type of loan.

Home equity

The portion of your loan principal you have already paid off is your home equity. Before you may refinance, the majority of lenders demand that you have some equity in your house.

You should be able to learn how to calculate your present home equity from your lender, as well as how much equity you require to be eligible for a refinance.

Will your monthly payment go up or down?

Your monthly payment will vary depending on the type of refinance you select. If you keep your term the same and refinance at a lower APR, your monthly payment will decrease. If you refinance to a longer term, your monthly payment will be reduced, but you'll pay more interest over time.

If you refinance for a shorter period, your monthly payment will go up, but you'll own your house sooner.

When you take a cash-out to refinance, your monthly payment often rises. Additionally, you could need to pay for private mortgage insurance (PMI) if your refinance leaves you with less than 20 percent equity in your home. 

A unique form of insurance called PMI covers your lender to a certain extent if you default on your loan. Ensure your lender discloses any PMI requirements since this could significantly increase your monthly payment.

Ask your lender how your monthly payment will change if you refinance. Your lender should be able to review the specifics of your loan and give you an accurate estimate of your monthly payment.

What are the refinancing costs?

The amount you'll pay will depend on several circumstances, but on average, refinancing costs 2 percent to 6 percent of the mortgage balance. These could be the loan size, the type, the length of the refinance, credit rating, and whether you're taking advantage of the equity in your property.

You take on a new mortgage when you refinance. This implies that you are responsible for paying the new loan's closing costs. 

You could have to pay the following closing charges when refinancing:

  • Application fees for loans
  • Origination fees for mortgages
  • Cost of a home appraisal
  • Title insurance
  • Credit report fee

Depending on the form of your new mortgage, you could need to pay additional costs. For instance, you will pay the VA funding charge, which ranges from 1.4 to 3.6 percent of the loan amount, if you are refinancing a VA loan. An upfront mortgage insurance cost is expected if you're refinancing an FHA loan.

What are your available refinancing options?

If you opt to refinance, finding the strategy that's best for you is essential. Compare different mortgage companies' refinance product offerings.

Remember that one refinance option can be more appropriate for a specific circumstance than another, such as accessing your home equity. Determining your objectives is crucial before continuing with the refinancing procedure for this reason.

Some of the most popular refinancing alternatives are shown below.

Rate-and-term refinance

Often known as a "standard refinance" by lenders, a rate-and-term refinance enables you to change the terms of your mortgage to ones that are more suited to your financial circumstances. 

With this refinance, you may get a lower interest rate, alter the length of your mortgage, and alter your monthly payments. A rate-and-term can be wise if you want to enjoy low mortgage rates or pay off your mortgage faster.

Cash-Out Refinance

Homeowners may convert their home equity into cash through a cash-out refinance.

In cash-out refinancing, your current mortgage is replaced with a new one with a higher principal balance. Your home equity withdrawal and the remaining mortgage balance make up the new mortgage amount. When the cash-out refinance closes, your lender will send you the cash sum you want to withdraw from your home equity.

Homeowners who require a lump sum of money to pay off debt, bolster a savings account, fund a home improvement project, and other uses may find a cash-out refinance a fantastic solution.

Cash-In Refinance

You can refinance to raise your home equity by adding additional money to your mortgage principal rather than using the equity you've built up over time as cash. This type of refinancing, known as a cash-in refinance, enables you to swap out your existing mortgage for a lesser one after making a single lump-sum payment.

You can obtain better loan terms with a cash-in refinance, such as a lower interest rate and smaller monthly payments. Furthermore, it assists in lowering your mortgage burden.
It's not always necessary to refinance.

Suppose interest rates rise, and you want to keep your current mortgage conditions the same. In that case, your lender may allow you to undertake a mortgage recast, a lump-sum payment that re-amortizes your loan over the remaining term for a reduced payment.

Several mortgage refinancing options might be more appropriate for your circumstances. These include a no-closing-cost refinance, a reverse mortgage, an FHA streamline refinance, and a VA streamline refinance.

Before making a choice, evaluate lenders and refinance product kinds.

Refinancing: Is it my best option?

Assessing your financial status and goals is crucial before determining whether or not to refinance.

  • Do you want to shorten the time it takes to pay off your mortgage?
  • Do you wish to lower your monthly payments?
  • Do you require a lump sum of cash to pay off debt or support a home improvement project?

Knowing your objectives will help you choose the best refinance and prepare you for the new loan terms.

You should also consider your qualification criteria, such as your credit score, DTI, and home equity. If you can only refinance if you fulfill the lender's requirements, you'll need to wait and try to improve these things. For instance, improving your credit score may enable you to lock in a lower interest rate.

The bottom line

Finally, you should ensure that refinancing makes financial sense. Compare your possible future savings with the costs of refinancing. A refinance might not be for you if it doesn't seem like you'll make money.
Lyle Solomon has extensive legal experience, in-depth knowledge, and experience in consumer finance and writing. He has been a member of the California State Bar since 2003. He graduated from the University of the Pacific’s McGeorge School of Law in Sacramento, California, in 1998 and currently works for the Oak View Law Group in California as a principal attorney.

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