Refinancing a mortgage means replacing your old home loan with a new one. Most people only refinance their mortgage to take advantage of a lower interest rate and to get significant monthly savings. However, the decision to refinance your mortgage should have a sound basis in your financial circumstances — the week’s trending mortgage rate should not be the only deciding factor.
So without further ado, let’s take a look at some of the things you need to know when considering mortgage refinancing.
Your Home’s Equity
According to CoreLogic, US homes saw their equity rise by a total of $1 trillion since the third quarter of 2020. However, some homes have not been able to recover their value and have low equity. Refinancing a mortgage with low equity may not always be possible with traditional bankers or lending agencies. However, there are a few government programs that can help you get a new loan.
Your best option is to visit a lender and discuss your unique situation with them. A homeowner with at least 20% equity may have an easier time applying for refinancing.
In recent years, even people who have quite good credit scores have not been able to qualify for lower interest rates. This is because most lenders have tightened their requirements for loan approvals and now want to see a credit score of 760 or even higher before they consider giving you a low interest rate.
Consumers with lower scores may still be able to get a loan but with significantly higher rates.
If you already have a mortgage loan, you may think that you may easily be able to get another loan. However, lenders have also tightened the approval standards with the debt-to-income ratio and now want to keep your monthly housing payments to under 28% of your monthly income.
Overall, the debt-to-income ratio should be no more than 36%; however, some lenders may go a bit above that if you have a high income, substantial savings, and a stable job history. You may also need to pay off some debt before you can qualify.
Mortgage refinancing can cost between 3% and 6% of your total loan amount, but there are some ways you can reduce the cost. If you have sufficient equity, you can wrap up the cost into a new loan, increasing your principal amount. There are some lenders who will be willing to refinance your mortgage for no extra cost, but you will need to pay a higher interest rate to cover the closing cost.
It is a good idea to shop around and negotiate mortgage deals as some lenders may be amenable to paying refinancing fees or reduce them.
When you are looking at your various mortgage loan offers, you need to not just look at the interest rate but also at the points. Points are equal to 1% of your borrowed amount and can be paid to lower the interest rate. Borrowers need to do some calculations to find out how much they can pay in points as they will be wrapped into the principal of your new loan or paid at the closing.
Private Mortgage Insurance
Homeowners who do not have at least 20% home equity will need to get private mortgage insurance if they want to refinance their home loans. If you have already taken out a PMI under your current mortgage, it will not result in a major difference. However, those who have not will find out that they will need to pay for PMI for the first time — and the additional cost of it may not be offset with the reduced payment from refinancing.
Your lender can calculate how much PMI you will have to pay and how much extra cost it will add to your monthly housing payment.
A lot of customers depend on their mortgage interest deduction to reduce their income tax. If you refinance and start paying a lower interest rate, your tax deductions will become lower. However, it is also possible that the interest deduction will actually be higher for the first few years of the mortgage loan. Increasing your loan size (as a result of wrapping in closing costs or taking out cash) will also affect how much interest you have to pay.
Keep in mind that when it comes to taxes, new provisions are announced regularly. Considering these changes, it is a good idea to consult your tax advisor for information on the effect of mortgage refinancing on your taxes.