Interest rates remain near historic lows, making it the perfect time for some borrowers to refinance and modify the terms of their original mortgage.
Refinancing is the process of replacing an old mortgage loan with a new loan. Some people refinance with the goal of getting a lower interest rate and monthly payment, whereas others refinance to pull money from their home equity.
While refinancing might be a smart financial move, it’s not the right choice for everyone. Whether you’re looking to pull cash from your equity, reduce your mortgage rate, or change your mortgage term, here are three questions to ask yourself before applying for refinancing.
1. How much equity do I have?
Buying a home is an opportunity to build wealth over time through equity, which is the difference between what you owe your mortgage lender and the current value of your home.
Equity increases as your home appreciates in value and as you pay down your loan. And one benefit of refinancing is the option to get cash from your equity with a cash-out refinance.
A cash-out refinance replaces your mortgage with a new loan of a higher amount—in which case, you’ll receive the difference as a lump sum.
However, the ability to refinance—and tap your equity—depends on the amount of equity in your home. Before you’re able to refinance, most lenders require a minimum of 5% to 20% equity. And you’re typically able to borrow up to 80% (sometimes 90%) of your home’s equity.
An appraisal determines the current value of your home.
Let’s say your home’s current market value is $300,000 and you owe $210,000. In this scenario, your lender might allow a cash-out refi up to $81,000. Keep in mind, though, cash-out refinancing increases the total loan amount. So instead of owing $210,000, you now owe $291,000.
If you’re approved, you can use funds from a cash-out refinance for just about any purpose, including home improvements, debt consolidation, or college tuition.
2. Do I have good enough credit?
Keep in mind, too, that having an existing mortgage doesn’t guarantee an approval, nor does refinancing guarantee getting a favorable mortgage rate.
Many people refinance with the purpose of reducing their rate and monthly payment. But interest rates are directly tied to credit scores, and borrowers with higher scores usually qualify for the best rates.
Since refinancing replaces your current loan, it also involves applying for a new mortgage. And in most cases, the lender will verify your income and credit to ensure you meet the minimum qualifications for a particular program, especially with a cash-out refi.
The only exception is with a low-doc streamline refinance that’s only available with government-backed loans (FHA, VA, USDA). If you apply for a streamline refinance with the purpose of changing your interest rate and term—and you’re not pulling cash from your equity—the lender doesn’t have to verify your income and credit, nor request an appraisal. They’ll use your payment history to gauge creditworthiness.
There’s no streamline program for conventional loans.
3. Should I refinance to a 15-year mortgage?
When refinancing a mortgage, you have the option of resetting your mortgage term for another 30 years.
Choosing another 30-year term offers the most affordable payment, but it is more costly in the long run. You’ll end up making more payments, and you’ll pay more in interest over time.
Depending on the age of the original loan, it might be better to choose a shorter term for the new mortgage, perhaps a 15-year term (assuming you’ve already paid on the house for 10 or 15 years).
On the other hand, if you’ve had the original loan for only five years, you might refinance into a 25-year term. This way, the payoff date of your new mortgage is similar to the payoff date of the original mortgage.
Switching to a shorter term is often more affordable when you’re not pulling cash from your equity, meaning your loan balance doesn’t increase.
Refinancing can modify the terms of your mortgage loan, reduce your monthly payment, and you can even pull cash from your equity. But the process doesn’t make sense for everyone. It’s important to know what’s involved and the minimum requirements to qualify.
To learn your refinance options—and determine whether it’s the right move for you—contact the local experts at FirstBank Mortgage.