What is Mortgage Refinancing?
In simple terms refinancing means taking out a new loan to pay off an existing loan. When you purchase a home, most people get a loan to buy the house. You have a mortgage lender that loans you the funds to purchase your home using your home as the security for the loan. You are quoted an interest rate and monthly payment which typically extends over a thirty-year period.
Homeowners often come across the opportunity to refinance their mortgage. Some homeowners find the perks of refinancing enticing, and many times refinancing can be beneficial to the homeowner depending on certain circumstances.
There are different types of loans available to homebuyers, from fixed-rate loans, to an adjustable rate loans. Depending on your credit rating, among other factors, your interest rate is determined during the application process of your loan.
One of the biggest reasons homeowners choose to refinance is the ability to receive a lower interest rate which means lower monthly payments. It may also mean being able to get cash back at the time of signing the new loan by drawing on the equity that has built up in the home.
Are there any negatives to refinancing?
Although there can be some real benefits to refinancing for many homeowners, there are also some negatives to refinancing that homeowners should be aware of.
Closing costs – There are closing costs associated with the new loan and are usually similar to those of any mortgage. If a lower interest rate is the motive behind refinancing, do the math to see how long it will take to recoup closing costs and begin seeing your savings to know if refinancing makes sense in your situation. Over long term, it may be worth the costs paid at closing. If your plan is to move in the near future, it may not be worth it.
Equity – If you have a lot of equity built up in your home and plan to use some for cash back at closing, there is a risk that you may wind up owing more on your mortgage than your home is worth.
What are the advantages of mortgage refinancing?
There may be good reasons to refinance a mortgage in certain situations.
If the primary breadwinner becomes temporarily disabled, underemployed, or unemployed, refinancing a home loan will reduce the monthly payment and ease stress on the family budget. When the budget increases, extra amounts can be paid on the new, lower mortgage payment to pay off the loan quicker.
Whenever the economy shifts and interest rates drop, refinancing a mortgage is often a great way to decrease the monthly payment and pay off the home quicker. However, this option needs to be balanced against the refinance application and appraisal costs, along with any others such as a prepayment penalty, to determine whether it is a cost-effective option.
Sometimes a borrower will refinance a mortgage loan with a different financial institution. Although this is typically done for a lower interest rate or better loan terms, sometimes the loan is switched and refinanced due to the borrower’s preference for a specific lender, its reputation, or any advantages to placing the mortgage loan with that institution. For example, some lenders offer gifts or advantages for mortgage applications, including cash bonus, point reduction, or lower interest rate. All of these should be compared carefully to ensure the borrower gets the best deal on the loan.
Refinancing a mortgage may be advisable when family situations change, such as the addition of a child, death of a household member, or a shift in financial circumstances. A borrower should not make a refinancing decision on short notice or based on an emotional response to events like these. The lender should be able to answer questions and provide adequate information about the pros and cons of refinancing a loan based on situations of this type, whether expected or not.
Mortgage refinancing can either reduce monthly payments while extending the loan for a longer period, or it can increase payments for a shorter loan. The household income and expenses should be evaluated based on current status and future expectations to make a refinancing decision.
What are the dis-advantages of Mortgage Refinancing?
Generally people will enter into a mortgage refinancing deal when the current interest rates are lower than the rate that they have or if they are looking to adjust the length of time that their loan is outstanding. There are many considerations that a borrower should make when deciding whether to refinance or not and should be aware of the disadvantages of undertaking a mortgage refinancing.
To start with when you enter into a mortgage refinancing loan there are closing costs associated with the mortgage refinancing that you will have to pay. As such, you will have to get a whole new loan with loan closing costs and this will only make financial sense if your new loan is significantly below the existing interest rate that you are paying on your mortgage.
When you enter into a mortgage refinancing loan you will undergo a new credit check. Any checks on your credit will lead to a lower credit score though the impact is typically not significant. However, if you are looking to enter into a new loan on top of the mortgage refinancing you may hurt your chances by entering into a mortgage refinancing loan on top of any new loans.
Another factor is the time that it will take to process a mortgage refinancing loan. Your time is not free and will often eat into and filling out the paperwork associated with a new mortgage refinancing loan can be time consuming and irritating. It is a good idea to consider whether the benefits that you incur will exceed the time you will spend on applying for the new mortgage refinancing loan.
As noted above there are many disadvantages associated with entering into a mortgage refinancing loan though there are times where the potential benefits outweigh the costs. Be cognizant of these concerns and wait until the rates are significantly below existing rates when making a change.
What are the costs associated with Mortgage Refinancing
One of the first costs you can expect is that you will have to pay for an appraisal. Now you may wonder why? Well if you are doing a refinance, the lender is going to want to make sure that the value of your home is in line for what you are asking for. The only way they will be able to tell that is to do an appraisal. So be prepared for that cost.
Now the next set of costs is commonly referred to as points. Now points usually break down into two categories. The first one is called discount points and that is usually prepaid interest that the homeowner pays up front and they do that to buy down the interest rate. The second is called origination fees and that is usually used to help compensate your mortgage originator. One of these fees will be included for sure in your costs.
Another cost that sometimes in included is what’s called credit fees and these are fees collected for running a applicants credit reports to make sure that the person applying for credit is credit worthy of a refinance. All in all there are other fees and costs that may be associated with you getting your mortgage refinance including things like lending fees, insurance fees, and escrow and title fees.
When looking at doing a mortgage refinance, always assume that there will be costs that you will have to pay but in the end it could help you save money in the long run. At the end of the day isn’t that what a refinance is all about?
Another fee you can expect to see is an application fee. Yes that is correct you will pay to have your application processed. Now that is one of the smaller fees that a person can expect, along with loan origination fees and possible home inspection fees if your home needs it.
Now since you are doing a refinance you can also expect that part of your closing costs will include a title search. The reason this is so important is because they want to make sure there are no hidden liens on the home, because when they do the refinance they want to make sure they are going to be in the number 1 position.
Now another closing costs that you would not probably want to pay or even have done is commonly called legal fees. Usually there will be a lawyer that makes sure all the paperwork is done properly and in legal order. Now you would not have requested the attorney but the lending company is going to make sure there is one to overlook the paperwork but you are going to be the one to pay the legal fees.
The cost for the appraisal (was the first cost we mentioned and had to go back over it). The reason that the lending company will want to do an appraisal is to make sure that the value of your home went up to match the new loan that you are looking to do. It used to be taken for granted that the home went up in value automatically but now you cannot guarantee it so lenders have to make sure they are making a good loan.
How Does Refinancing Affect Your Credit Score
Refinancing does not have a negative effect on credit scores if done in the right way. There are a few things one must know before the decision is made to refinance. The first being how to shop for the best rates.
The overall goal in refinancing is to reduce the monthly payment. It may be tempting to get a quote here and there to see what the best rates are, but this will have a negative effect of your credit score. It is recommended that a person looking to refinance do all the rate shopping in a two week period. The reason behind this is that the way your credit is looked at. If a number of hits to your credit score is made within a short period of time the credit bureaus will not dock as many points. Basically, you credit score will be pulled at relatively the same time at all places. Not limiting “rate shopping” to a two week period will result in your credit score being pulled at random times and each time there will be a deduction of up to 10 points.
This is a short-term effect on your credit score. Even if a number of hits are made to your credit score over a long period of time, the damage can be repaired with not allowing your credit to be pulled for a few months. Good credit will remain intact as long as payments are made on time and the credit is maintained.
It is also recommended that you have a well-established credit history before refinancing. Having a long line of credit history will allow for fewer dings when credit is pulled. It works like an average. Having too little on a credit score brings the average down. A thick credit portfolio shows active credit and the credit bureaus will allow for fewer points to be taken away.
The damage to a credit score during the refinance process is minimal, but any finance end devour should be taken on with care. Proper research should be done as to when and where the refinance should take place.
Key Things To Note When Refinancing: