You’ve owned your home for a few years and may be considering refinancing it. How do you know if now is the right time? Although refinancing can be a viable option in the right circumstances, there are several things to consider before initiating a new mortgage on your house.
What is Refinancing, and Why Should You Consider It?
To refinance your mortgage, you’ll need to take out another home loan to pay off your existing loan. The loan amount will be smaller than your original mortgage, resulting in lower monthly payments.
Refinancing your mortgage is something all home-owners should consider, especially if you can find a loan with lower interest rates than what you currently pay. Refinancing can reduce the total amount you will pay for your mortgage.
Mortgage Payments Breakdown
Every month, you pay a predetermined amount, which includes both the principal and the interest. However, whether you pay more on the interest or the principle will change over time, a process called mortgage amortization. Initially, your payments will mostly cover your interest.
As you pay off your mortgage, your payments gradually cover more of the principal. If you refinance after the focus of the payments changes, you will once again be paying primarily for the interest, increasing your cost in the long run.
Benefits of Refinancing
Refinancing can lower your debt-to-income ratio, which is the amount of debt you have compared to your household’s amount of income. A low debt-to-income ratio can make it more comfortable for you to meet your monthly payments.
A lower debt-to-income ratio can also increase your credit score and your monthly savings. A better credit report makes you eligible for larger loans and better interest rates.
If you plan your refinancing right, you can change the length of the term. Choosing a shorter-term loan instead of a 30-year mortgage might raise your monthly payments, but it reduces the time and amount of interest you pay on the loan.
Risks When Refinancing
Timing is everything when you’re refinancing. You should consider the housing market conditions in your area and the prevailing interest rates to determine if the action is worth it.
In addition to market timing, you should also consider the costs of refinancing. When you refinance, you’ll pay your existing mortgage off early. If your original mortgage had a prepayment penalty clause, you’ll need to include that fee in your calculations when determining if refinancing is right for you.
Other fees involved in refinancing include paying for a title search and title insurance, closing costs, and lawyer fees.
You’ll also need to consider the current state of the housing market. The demand and supply of housing in your area, stock market conditions, and general economic circumstances all affect your home’s current value and the interest rates.
If the market conditions have changed since you purchased your home, you might find your home’s market value has reduced to less than the amount you have left on your principal, resulting in a loss of equity.
Types of Refinancing
You can choose from cash-out refinancing, change of duration refinancing, lower rates, structure changes, or mortgage insurance removal.
The cash-out refinance option is often used for home improvements. This option gives you a loan for more than the principal you owe. You can use the extra money from the loan to pay for repairs to increase your home’s value.
Some homeowners initially choose an adjustable-rate mortgage (ARM), which has a mortgage rate that fluctuates with market conditions. Adjustable-rate mortgages can be beneficial at times, especially when rates are low. However, when rates increase, your mortgage payment rises as well.
ARMs usually come in a mix of different fixed and variable periods. For instance, you might have a hybrid adjustable-rate mortgage with a fixed period of 5 years and an annual rate increase of 1. This is called a 5/1 mortgage loan, where the fixed rate has a set period of five years, followed by a rate that adjusts annually. Adjustable-rate mortgages come in different periods, including a 10/1 or 3/1.
If you move frequently, a 5/1 mortgage loan may be a good option, but you might consider refinancing to a loan more suitable for extended home ownership if your plans change. A fixed loan allows you to establish a set budget and the opportunity to pay extra toward the principal, shortening the term of your mortgage.
If you were a first-time homebuyer, your lender might have required private mortgage insurance (PMI), an insurance you pay on your mortgage. It protects your lender if you default on the loan or fall behind on payments and can help you qualify for a bigger loan. Refinancing can help you eliminate PMI by reducing your debt-equity ratio, which gives a lender more confidence in your ability to keep your payments current.
Contact T&I Credit Union
There is a lot to think about before refinancing your home. At T&I Credit Union, we make refinancing your home easy and help you through every step of the process. We strive to make sure you are informed before deciding to refinance your home. Contact our team to learn more about how you can refinance your mortgage responsibly.