When you took out a variable or fixed-rate loan for your home, you probably thought the interest rate you had was the best available at the time. The same applies to your car loan, small business loan, or loan to pay for your latest around-the-world vacation. Have you thought about it at all in recent months? Did you realize that interest rates change? Mortgage rates, in particular, fell significantly during March of this year. Since then they have been moving upward, albeit very slowly. Taking advantage of this adjustable rate can be a smart thing to do.
One of the best times to think about refinancing is when interest rates are falling. Whether it’s your mortgage, student loan, auto financing, or any other form of lending, it’s the sensible thing to do.
To make things simpler, we’ll consider the various implications for anyone wanting to refinance their mortgage. If it’s another type of loan you want to refinance, most of these points still apply.
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What Does Refinancing Mean?
Refinancing is the replacement of an existing loan with an option that suits your needs better. People often choose to do it to take advantage of a better variable or fixed mortgage rate. Another reason could be to combine several loans into one debt consolidation loan and be left with one easy-to-manage payment. It’s also a standard step in any debt management program, particularly if you’re struggling with your current monthly mortgage payment.
What Are the Benefits of Refinancing?
As you might expect, there are some rather significant benefits of refinancing a loan. They are as follows:
Lower Interest Rates
If you took out your loan when interest rates were high, refinancing your mortgage allows you to find a better variable or fixed rate. Interest rates are always changing. While you might have tied yourself into your deal, to begin with, there’s no reason why you shouldn’t get a better deal if you can. A drop of just 2 percent on a balance of $150,000 could save you more than $29,000 in interest. With a reduction in interest rates, there’s the bonus of reduced monthly payments. There’s also the option of an adjustable-rate mortgage.
When you’re looking at different interest rates, it’s essential to pay attention to the APR, or annual percentage rate. The APR is not the first figure that jumps out, but it must be listed. You generally find it to the right of the base interest rate. Lenders also consider closing costs, origination fees, and other charges when calculating the APR.
Changing the Term of the Loan
Refinancing also allows you to change the term of your loan. It’s possible to do this by increasing or decreasing it. If you decide on a shorter term, you’re likely to see a drop in interest rate. You may, on the other hand, see an increase in your monthly payments because you’re giving yourself less time to repay the loan.
If you decide to change to a longer-term loan, your monthly payments will be lower, but the interest rate you’re charged is likely to be higher.
Which one you choose is more of a personal choice and depends on your financial circumstances.
Changing the Type of Loan
Whatever type of loan you’ve got, there are always several different options. If you’ve got a mortgage, for example, you might have the opportunity to take out an FHA loan (Federal Housing Association loan). You can take out this type of credit with a much lower down payment and FICO score. FHA mortgage rates are also very reasonable. However, you will have to pay upfront and monthly mortgage insurance premiums.
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Cashing Out Equity
As you pay off your mortgage, your equity increases. It’s possible to take advantage of this increasing equity by taking a cash-out to refinance deal. You replace your existing mortgage with one for more than you owe on your home. Choosing a cash-out refi deal means you get extra money you can spend on home improvements or the vacation of a lifetime.
Consolidating Existing Debt
Debt is commonplace in today’s modern world. However, sometimes credit card debt and other debts can creep up on you. Before you know it, you’re faced with lots of different payment deadlines to manage. When this gets very confusing, it’s all too easy to fall behind or miss payments completely. The result is spiraling interest rates and expensive charges that only increase your debt. A solution is available in the form of a consolidating loan that combines all your debts into one easy-to-manage payment.
These are all excellent reasons for you to consider cash-out refinancing or any other type of deal, but how does it work?
How Mortgage Refinancing Works
The process is straightforward. The lender pays off your existing loan and creates a new one. However, there are several steps you must take.
Find a Lender and Loan That Suits Your Needs
Shopping around for the right lender is a crucial step to take. You want them to be able to offer a new loan that matches your needs with the right terms and at a reasonable cost. You might be able to get a great deal from your current lender, but if you can’t, you should shop around. Check with a variety of different lenders, including credit unions, banks, and mortgage brokers. The more variable and fixed-rate details and information you gather to compare, the better your chances of finding the best deal.
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Complete the Application Form
Completing an application form is another vital part of the process. Without it, you’ll never get approved. Present the application to the lender with specific documentation. Knowing what these documents are means you’re better prepared when the time comes. You’re likely to be asked for the following:
- Proof of income – This proof includes the last month’s pay stubs, current tax returns, and various tax forms.
- Insurance – You need homeowners’ insurance to confirm the coverage for your home is sufficient. You also need title insurance, which helps the lender clarify legal ownership of the property and check the taxes.
- Credit information – Your lender could request this information, but you can speed up the process by providing a recent credit score and reports.
- Debt information – Your lender will need to see information about your other debts to determine your debt load. Gather documentation for your current mortgage, credit cards, home equity loan (if you’ve got one), student loans, and auto loans.
- Financial assets – You must provide documentation for all your assets, including your home, stocks, bonds, savings accounts, CDs, mutual funds, other real estate, and retirement accounts.
- Appraisal of your current home – Your lender may request a current appraisal of your home. You might also need to include a loan-to-value assessment. This assessment is a figure for how much your home is worth compared to the amount outstanding on your current mortgage.
With the application form completed and all the correct documentation provided, the lender must now process your application.
The Lender Assesses Your Application
How long this takes depends on several variables. For your peace of mind, find out the loan officer who has been assigned your application and keep in touch. Additional information or documentation may be requested. Make sure you do this swiftly, or you’ll be holding up the process.
Contracts Are Issued, and the Loans are Changed Over
When a refinancing loan is approved, you receive disclosures that you must review. The disclosure includes details of the final third-party refinancing costs, loan balance, and prepaid costs. Return the paperwork to your lender, and the funds are sent, allowing your current mortgage to be repaid.
Factors to Consider Before Refinancing
To help you decide, consider the following factors.
The Equity You Have Left in Your Home
The value of the property has seen some significant drops previously, but the good news is that home values are on the rise. Hopefully, your home is one of them, and it’s managed to regain its value. If you’re not one of the lucky ones and you have little or no equity, refinancing is not always possible with a traditional lender. However, there are specialist lenders, and government programs are available. The best way to find out whether you qualify for a refinancing loan is to contact a selection of lenders. The ideal amount of equity to have is about 20 percent.
The State of Your Credit Score
Lenders use your credit score to help them decide how likely you are to repay debt. It’s a three-digit number that’s created by the three main credit bureaus: Experian, Equifax, and TransUnion. If you want a lender to offer you the lowest interest rate, your credit score needs to be 760 or above. That doesn’t mean you won’t be eligible for refinancing if your credit score is lower. However, it does mean the interest rates or fees are higher.
If your credit score is not looking very good, there are several things you can do to make it better.
Personal Debt-to-Income Ratio
Your debt-to-income ratio (DTI) is a way of measuring the amount of debt you have compared to your gross income. It’s straightforward to calculate. Divide your total regular monthly debt by your gross monthly income. The resulting figure should be 36 percent or less. Lenders take various other factors into account when deciding whether you qualify for a loan. Some examples include having lots of savings, a long and stable work history, and a high income. The debt-to-income ratio also plays a significant role. If yours is more than 36 percent, consider paying off some of your debt before refinancing.
The Cost of Refinancing
There is a standard cost of between 3 percent and 5 percent. However, it is possible to reduce the fees or include them in the loan. This is an attractive option, as long as you’ve got sufficient equity in your home. You might be lucky to find a lender offering a no-cost refinance, but don’t count on this being an option. It might also mean you pay a slighter higher interest rate, as this is one way for the lender to recover the closing costs.
Rate vs. Term
The interest rate is not the only factor you should consider. The term of the loan is of equal importance. You must decide on your goals when you’re looking for a refinancing product to meet your needs. Ask yourself the following questions:
- Do you want to reduce your monthly payments?
- Want to pay less interest?
- Pay off your loan as quickly as possible?
The answers to these questions will determine whether you need a product with a low-interest rate, long term, or short term.
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Refinancing Points
Do you know what refinancing points are? They are points paid to a lender at closing. You pay these points in exchange for a reduced interest rate or to cover the fees charged for creating the loan. Generally, when refinancing an original mortgage, one refinancing point is equal to 1 percent of the total amount of the new loan. Remember to include them when making your calculations.
Do You Have a Break-Even Point?
Your break-even point is the point at which the cost of refinancing is recouped. Once this has happened, any savings you make are yours to spend as you wish.
Private Mortgage Insurance (PMI)
When the equity in your home is less than 20 percent, you’ll be required to pay private mortgage insurance (PMI). Some of you might already be paying this additional expense, but if you’re not, you need to add this to your housing costs.
Taxes
Are you reducing your federal income tax bill with a mortgage interest deduction? If so, by refinancing, you’ll be paying less interest; remember, this means your tax deduction might also be lower.
You’ve now got enough information to help you answer the question, “Should I refinance my mortgage?” To finish up, let’s look at two more types of refinancing that are becoming increasingly popular.
Should I Refinance My Student Loans?
Millions of people solve the problem of how to pay for college by taking out a student loan. The good news for anyone with such a debt hanging over their heads is that student loan rates have hit an all-time low. Now is a great time to refinance student loans. The Federal Reserve has cut interest rates, and this has had a knock-on effect on student loan refinancing rates.
There Are Several Benefits, Including:
- Interest rates will be lower
- Pay off your student loan quicker
- Save money
- Flexible repayment terms of between five and 20 years
- Both fixed-rate interest and variable interest rates are possible
Tips On Refinancing Your Student Loan
If you’re wondering whether to refinance your student loans, the process is simple. However, it’s essential to understand the various steps you must take.
- Find the best interest rate – While it might be a good time to refinance, you must make sure you get the best variable or fixed rate possible. Do your research and shop around for the best deal. It’s possible to check preliminary interest rates online without it affecting your credit score.
- Use a student loan refinancing calculator – Many lenders offer a free online calculator, so it’s easy to work out what you’re going to pay. You’re also able to calculate how much you’re going save.
- Apply online – It is possible to apply for your refinancing loan online. It takes just 10 or 15 minutes out of your day to do that. You will need to upload various documentation as well. This might include a copy of your driver’s license, recent pay stubs, or a job offer letter.
- Criteria – You’ll need to meet specific criteria if you want to increase the chance of approval. You need a credit score of 650 or above, a regular income, and current employment or a written job offer. A low debt-to-income ratio is also beneficial, along with no defaults on your student loans. If you don’t meet any of these criteria, it is still possible to apply, but you’ll need a co-signer.
- Fees – There are no fees when refinancing a student loan. Avoid lenders that try to charge you. Prepayment penalties are something else you don’t have to pay.
- Federal student loans – Only refinance your federal loans if you’re not planning to take advantage of public service loan forgiveness or an income-based repayment plan. If you want access to deferral or forbearance options, it’s also not a good idea to refinance.
- Reasons to refinance – There are a few reasons why you might consider refinancing. One of the most common reasons is to save money. Another common reason is if you’re struggling to meet your current loan obligations.
Refinancing a loan is a big decision to make. It’s therefore vital you make it when in possession of all the facts. There are plenty of lenders able to provide such a service, and it’s equally important to choose the best one.
Refinancing Your Car Loan: Does It Make Sense?
Have you taken out a loan to pay for your car? If you have, you might be interested in learning about refinancing. One reason for doing it is that it can save you money. Hopefully, you’ll be able to secure a much lower interest rate. The result will be a reduction in your monthly payments and will perhaps even free up some cash for your other financial obligations.
There are several occasions when refinancing your car loan makes perfect sense.
- A drop in interest rates – If interest rates have changed considerably since taking out the loan, there’s a big chance you could save money.
- If your financial situation is looking much healthier – When you took out your car loan, the lender would have considered several factors that would have influenced your auto loan rate. If your credit history and other factors have changed, you could be eligible for more favorable terms.
- Better terms are available – However long you’ve had the loan, it’s always a good idea to keep an eye out for better loan terms.
- If you’re struggling with your monthly financial commitments – A longer repayment term can help to reduce your monthly repayments.
Are you confident that refinancing is for you? Are you about to start your research? Tell us about how the process went and about your experiences. There are also going to be lots of other people who would benefit from your first-hand knowledge. We might have left out some vital piece of information, and you’ll be able to fill the gap in the comments.
