Refinancing Options and When It’s Best to Use Them

If you’ve owned your home for any length of time, you’ve probably received countless offers to refinance your home. These offers all promise big benefits to you for refinancing your home loan, but can they really deliver? More importantly, how can you tell if it’s the right offer for you? The better you understand your mortgage refinancing options, the more informed your decision, when the time comes, will be. Below are some of the important details you need to know about your refinancing options and when it might be best to take advantage of a specific choice.

What Does It Mean to Refinance Your Mortgage?

When you refinance your mortgage, you’re essentially starting over with a brand new mortgage. The difference is that this mortgage will have different terms and requirements than the original mortgage. People seek to refinance their mortgages for a variety of reasons, that may include any of the following, or something else entirely:

• Reduce monthly payments.
• Lower interest rates.
• Cash-out equity in the home.

Doing so, strategically, can help homeowners get more mileage from their mortgages. However, doing so at the wrong time or getting unfavorable terms can cost them more in the end.

One of the key factors when considering refinancing a mortgage is the interest rate. If you can’t reduce the interest rate by refinancing, that might not be the best option for you at the moment. That is, of course, unless you have a specific goal in mind of cashing out equity to fund something important to you and your family, such as paying a child’s college tuition, funding one last family vacation of a lifetime, paying off crippling credit card debt, etc.

What Do You Need to Refinance Your Home?

Since most people who decide to refinance their homes are looking to improve their financial situations either by lowering their interest rates, substantially reducing their loan term, or simply reducing their monthly payments, it makes sense that you will need to qualify for more favorable terms this time around than your original loan delivered. These factors can help you get more mileage from your mortgage refinance options:

• Stable employment history.
• Improved credit score.
• Low debt-to-income ratio.
• Increased equity in the home.
• Rising property values.
• Amount you intend to borrow.
• Demonstrated ability to repay the loan.

If you have an FHA mortgage and are considering an FHA streamline refinance loan, the only thing that really matters is your payment history with your existing FHA mortgage.

How does Mortgage Refinancing Work?

In the best-case scenario, you have two things working in your favor if you’re thinking about refinancing your mortgage.

1. Property values in your neighborhood are on the rise. Thus, increasing the value of your home and your equity in it.
2. You’ve been making regular mortgage payments for quite a while. Building up equity and edging closer to or over the magical 20 percent mark.

When these things work together, your loan-to-value ratio improves, which can lower your interest rate in its own right, and the amount available to cash out, good news for those seeking cash-out refinance mortgages, rises.

What are Your Mortgage Refinancing Options?

There are four primary mortgage refinancing options to consider that are widely available today:

1. Rate and term refinance. This plan is about reducing one or both in the repayment process.
2. Cash-out refinance. It allows you to cash out the equity in your home – for whatever reason you like.
3. Cash-in refinance. Adding a lump sum payment to create a reduced monthly payment.
4. Home Affordable Refinance Program (HARP). Allows “underwater” borrowers to refinance up to 125 percent of their home’s value to reduce their interest rates.

Each option offers specific benefits, strengths, and weaknesses to consider.

How do You Know Which Option is Best for You?

Ultimately, choosing the right mortgage refinance option involved knowing what your specific goals for refinancing your home happen to be. Those who owe more than the current value of the home, for instance, have only one refinance option. This one may not reduce the term of their mortgages, but it can help them reduce their monthly payments to something that is infinitely more manageable.

For people who want to reduce their interest rates or the duration of their monthly mortgage payments, the rate and term refinance option is the most expedient. That is, UNLESS, they have a large lump sum to invest in their homes. In that case, the cash-in refinance may provide more favorable results.

Finally, for those interested in getting cash from the equity in their homes, there is only one option to consider, the cash-out refinance. This allows borrowers to remove some or all the equity in their homes to have cash on hand.

Are there any Risks Involved in Refinancing Your Mortgage?

One of the biggest risks involved in refinancing your mortgage is doing so for the wrong reasons. Refinancing is an attractive option to homeowners who are seeking relief from higher interest rates, want to lower monthly payments, or even want to repay their mortgage for fewer months or years. However, it is not the only solution to consider and may not even be the best.

For instance, debt consolidation by refinancing your mortgage is a risky business. It may be tempting to wrap up your high-interest credit card debt into your mortgage, but the risk is much larger when doing so – especially if you go right out and accumulate more credit card debt.

It is also a risky move if it extends the duration of your loan. By extending the length of repayments you are exponentially increasing the overall costs of ownership for your home. Plus, you are lengthening the amount of time in which you are at risk of losing your home due to non-payment. It is rarely in your best interest to extend your loan.

Finally, if it will be a huge struggle for you to pay the closing costs involved in refinancing your home, it might not be in your best interest to do so.

How Much Does it Cost to Refinance Your Home?

There are costs involved in refinancing your mortgage. While some lenders do offer “no closing cost refinancing” there are other costs to keep in mind, including:

• Inspection fees
• Appraisal costs
• Attorney fees
• Title fees
• Origination fees

Trulia reports that the average cost of refinancing a home range between $1,500 and $5,000, which is one reason why refinancing a mortgage is not recommended for people who plan to move within the next two years.

Are There Times When Refinancing is Not the Right Move?

Absolutely. If you can’t secure more favorable terms by refinancing, there is no point in attempting to do so. Another consideration is how long you’ll remain in the home after refinancing the loan. In other words, soldiers waiting on orders to relocate within the next two years would be better served to wait rather than refinancing their mortgages. It takes about two years to recoup the costs involved in refinancing a mortgage.

Other times when it is not in your favor to refinance your mortgage include when you have a prepayment penalty attached to your mortgage and if you’re near the end of the tunnel and have already paid off a good portion of your mortgage.

Can You Refinance FHA, VA, Jumbo, or USDA Loans, Too?

Yes, you can! In the right situations, you may be able to secure more favorable and easier to accomplish refinancing options for government-backed loans, like these as well. Work with your preferred lender to determine if it is better for your unique situation to go with a streamlined refinance or to try to go the conventional route instead.

Are there Alternatives to Refinancing that Can Lower Your Monthly Mortgage Payment?

The good news is that there are things you can do that will help to reduce your monthly mortgage payments without refinancing your mortgage. One of the simplest is one that can happen before you even begin making payments on your mortgage. If you pay at least 20 percent down on your mortgage you won’t need to carry private mortgage insurance for a conventional loan.

• The larger your down payment, the less you ultimately finance on the home. So, making a larger down payment is better all around. It can even improve your loan-to-value ratio which can, in turn, reduce your interest rate on the loan even further.
• The next big thing you can do to reduce your mortgage payments is to get rid of your PMI. With some loans, mortgage insurance is a fact of life. It will be there for the life of your loan. However, with conventional mortgages, you can eliminate the need for private mortgage insurance by paying 20 percent or more down on your home or reaching 20 percent equity in the home, you can petition to have the private mortgage insurance removed from your monthly payment.
• Lower your monthly escrow requirements. Your monthly mortgage payment is often much more than just the principal, interest, and PMI on your home. Most banks require escrow for taxes and insurance, so they can be certain both are covered as long as they have some “ownership” stake in the home. You may consider requesting a new tax assessment from your county (be warned, it could trend higher, costing you more). Another option is to explore your home insurance alternatives to reduce that monthly payment.
• Home equity lines of credit (HELOCs) can be a better option for people who just want access to some of the equity in their homes on an as-needed basis. This line of credit operates much like a credit card. This one uses the equity you have in your home as collateral and the interest rates are variable. The variability of the interest makes this a less than attractive option to some consumers, however. If that applies to you and you’re not looking for the ability to borrow against the equity in your home on an as-needed basis, a home equity loan might be a better choice.
• Finally, if you ever have the opportunity to invest a large lump sum of cash into your mortgage, through a bonus, an inheritance, etc., do so and then recast your loan. There is usually a fee involved for the service in which banks reassess your loan based on the amount currently owed, reducing the remaining monthly payments, allowing you to pay lower payments each month for the remainder of your term.

Depending on your needs and your financial goals, refinancing your mortgage may be one of the wisest decisions you can make. However, it is one that should not be made lightly. Keep these things in mind to choose the right refinancing option for you.