To refinance a mortgage means to replace an existing mortgage loan with a new one. With a refinance, the principal balance of the existing loan is paid-in-full using the balance of the new loan.
When the refinance is complete, your old loan is retired — replaced with a new mortgage loan with new mortgage terms.
There are lots of reasons why a homeowner would want to refinance.
Sometimes, a homeowner refinances to exploit a change in market conditions, such as a change in today’s mortgage rates or a rise in local home values. A new mortgage can give lower mortgage rates or payments to the homeowner, and can remove private mortgage insurance (PMI) payments.
Other times, a homeowner refinances to take “cash out” for a home improvement project, or to fulfill legal obligations, such as the removal of an ex-spouse from a mortgage loan.
There are dozens of reasons why a homeowner would want to refinance. However, the two most common reasons are to lower the loan’s mortgage rate; and, to lower the loan’s monthly payments.
When you’re considering a refinance, then, define your goal first — what is it you’re trying to accomplish? Then, consider all of your available mortgage refinance options.
Refinancing your mortgage means getting a new loan to pay off your existing loan. Depending on your current financial or personal situation, there are many good reasons to refinance. Based on the type of loan you choose, there are a lot of great benefits too.
Here are the most common reasons homeowners seek to refinance:
Get a lower interest rate. A lower rate often results in lower mortgage payments. You can use the extra money each month to pay off debt, for savings or investments, or to spend however you like. ** Refinancing your existing loan may result in higher total finance charges for the life of the loan.
Get a shorter loan term. You may end up with a comparable, or slightly higher, monthly payment, but with a shorter term you’ll pay off your loan sooner. You’ll save a ton of money over time by paying less toward interest, and you’ll build equity faster, increasing your net worth.
Switch from an adjustable to a stable fixed rate loan. Switching from an adjustable rate mortgage (ARM) to a fixed rate loan gives you predictable monthly payments over the life of the loan. You won’t experience dramatic monthly payment increases, making long-term budget planning easier.
Turn your home’s equity into cash. Cash-out refinancing turns the equity in your home into cash. From paying off high-interest credit cards to taking a dream vacation, there are no restrictions to how you use the money. And there are no tax penalties for accessing or using this money.
A Cash-out refinance is any type of loan that is used to tap into the equity of your home and utilize it to access cash to use for other things.
The amount of money that can be taken out when getting a cash-out refinance depends on a number of things. The type of mortgage (Conventional, FHA, VA) will dictate what percentage of the equity can be taken out as well as the occupancy type of the home, i.e. is the home that is being used for the cash-out refinance a primary residence, a secondary home, or an investment property. A good rule of thumb, however, is that a home owner can typically take out up to 80% of the equity of their home and utilize it.
Cash that is taken out when doing a cash-out refinance can be used for anything that a home owner wants, including, but not limited to, paying off other higher interest bearing accounts such as credit cards and car loans, to using the money for home improvement and renovation projects.
The interest rate for a cash-out refinance will be dictated by a number of factors, aside from the loan type, the main factor will be what the loan to value or LTV is for the cash-out refinance. Essentially, the higher the loan to value, the higher the risk to the lender, and the higher the interest rate can be on this type of transaction. Closing costs on a cash-out transaction will be no higher than customary with any type of mortgage. Expect to pay on average, 2-5% of the loan amount as closing costs. This means on a $200,000 loan, you can expect to pay between 4-10k in closing costs depending on what costs are customary in your part of the country.
To qualify for a cash out refinance, you need to have equity available in the home that you own. You generally also need to have a credit score of at least 640.
There are both pros and cons of doing a cash-out refinance. Pros would include reducing debt and increasing monthly residual income. By paying off higher interest bearing accounts, you will pay much less in interest over time. By paying off credit cards and other debt, this may improve your overall credit profile and your credit score could benefit from a cash-out refinance as well. Finally, depending on what you use the cash for, you may create a Tax benefit for yourself when you do a cash-out refinance. If money is used for energy-saving home improvements, you may qualify for certain tax deductions and also, for some homeowners, depending on the tax code, some may find mortgage interest paid is tax deductible as well. The cons to a cash out refinance include having to pay closing costs, this is something that should not be overlooked when factoring in whether a cash-out refinance makes sense in the long run. Other cons include the possibility of creating bad habits in so much as if you utilize the cash from your home to pay off debts but then go and charge up your debts again, you may face higher monthly expenditures than you previously had and you may run the risk of foreclosure if you continue to charge up debt and have a higher monthly mortgage payment due to the original cash-out refinance.
There are a few alternatives to a cash-out refinance one of which would be a personal loan. A personal loan does not tap into the existing home equity of your home or have anything to do with your mortgage. A personal loan may have fewer closing costs associated with the loan, but may have a higher monthly payment as they usually are not made for 15 or 30 years like a mortgage is. Another alternative to a cash-out refinance which still taps the equity in your home would be a HELOC (Home Equity Line Of Credit) or a second mortgage. Both of these alternatives would be mortgages which would go into second position to your primary mortgage and would be a separate payment from your current first mortgage.
If your home or current mortgage meets one or more of these three conditions, it’s a good time to consider refinancing.
Your current mortgage is relatively new. In the early part of many mortgages, most of the monthly payment goes toward interest. If you can get a new mortgage that applies more of your payments toward the principal, that’s good. You’ll build equity faster. It’s like paying money to yourself.