Borrowers refinance to get a loan that better meets their financial needs that have shifted over time or when mortgage or real estate market conditions change. The most common reason for refinancing is to get a lower interest rate. Refinancing a home loan with a lower mortgage rate can help you reduce your monthly payments and pay less interest over the life of the loan.
Before you decide refinancing your home loan
If you’re thinking about switching home loans, you’re probably focused on getting a better interest rate. But there are other things to consider before switching.
Tell your current lender you are planning to switch to a cheaper loan offered by a different lender. To keep your business, your lender may reduce the interest rate on your current loan.
If you have at least 20% equity in your home, you’ll have more to bargain with. Having a good credit score will also help with negotiations.
Compare any loan they offer you with the other loans you’re considering. See choosing a home loan for tips on what to look for.
5 Best Reasons to Refinancing Your Home Loan
Rate
It’s a mistake to wait until interest rates are in the news to start a refinance. Once it’s widely known that rates have fallen, refinance applications soar. Lenders have more business than they can handle, and that means refinancing a mortgage can take longer and cost more.
Preparing ahead of time with two smart actions can keep you from missing out.
First, find your target rate. At what interest rate would it make sense for you to refinance? Take a look at current refinance rates, run the numbers through a refinance calculator, and see if the savings will outstrip the loan costs in a reasonable amount of time.
If not, run the numbers again with a lower interest rate. Do this until the refinance would generate the needed savings — that’s your target rate or “trigger rate.”
Second, get preapproved for your refinance, which allows you to deal with an unexpected problems — such as a mistake on your credit report — without being under pressure to close before a rate lock expires. With a preapproval, as soon as rates drop into your strike zone, you can lock your loan and close your refinance quickly.
Term
You can either extend or shorten the term on your loan according to your budget. It’s always appropriate to refinance if you can reduce your interest rate at no cost or if you’ll recoup the refinancing fees before you sell your home.
However, savings are guaranteed only if you avoid extending your repayment. By choosing a refinance with a shorter term or by paying a little extra toward your principal each month, you get the benefit of a lower interest rate without extending your repayment. (Your loan officer can tell you how much to pay, or you can work it out with a mortgage prepayment calculator.)
Cash-Out
A cash-out refinance might be a great opportunity for you to tap into some of your home equity. Use this financial tool wisely. A cash-out refinance replaces your existing mortgage with a new home loan for more than you owe on your house.
The difference goes to you in cash and you can spend it on home improvements, debt consolidation or other financial needs. You must have equity built up in your house to use a cash-out refinance.
Traditional refinancing, in contrast, replaces your existing mortgage with a new one for the same balance. Here’s how a cash-out refinance works:
Pays you part of the difference between the mortgage balance and the home’s value.
Has slightly higher interest rates due to a higher loan amount.
Limits cash-out amounts to 80% to 90% of your home’s equity.
Divorce
To understand whether you need refinancing your home loan after a divorce, it’s important to understand the differences between the names on the mortgage and the names on the title.
The names that are on the mortgage show who’s responsible for paying back the debt. If both you and your ex-spouse’s names are on the mortgage, then both of you are liable for the mortgage payments.
If your ex-spouse is on the mortgage with you, there are a couple of ways to remove their name from the mortgage. First, you can ask your lender for a release of liability. This is a document that releases a borrower from their obligation to pay back the loan. However, there’s no guarantee that your lender will issue one.
If you can’t get a release of liability, then the only other option is to refinance the mortgage. When you do this, the spouse remaining on the mortgage needs to qualify for the new loan using only their income and assets.
The names on the title, on the other hand, show who owns the home. It’s possible to be on the title without being on the mortgage. For example, if one of you didn’t have income at the time you got the mortgage, then it may have made sense for only the income-earning spouse to apply.
If your ex-spouse is on the title to the home, removing them from the title is only a matter of paperwork. You can have your ex-spouse sign a quitclaim deed, which will transfer their ownership of the property to you. You’ll need to do this to refinance the home.
If you aren’t able to get a release of liability or qualify for a refinance without your spouse, then an easier path may be selling the home. Selling the home allows you to easily split the proceeds of the home. That way, you can divide your assets and move forward.
Mortgage Insurance
Refinancing a mortgage can help you get rid of private mortgage insurance (PMI) sooner. You can request PMI cancellation as soon as your loan balance hits 80 percent of the original home value (when the loan was closed), and PMI is automatically canceled once your loan hits 78 percent of the original balance.