Refinancing a home: planning before refinancing

Refinancing a home: planning before refinancing

Millions of homeowners have an opportunity to refinance their homes when the interest rate is lower. According to the Frieddiemac mortgage rate report, since 1971, the mortgage rate has dropped significantly, especially in 2020-2021. The decline in the interest rate combined with the increase of home prices gives you a good opportunity to refinance your home mortgage and save a large amount of money over the life of the loan.  However, note that you have to pay for fees on refinancing. Therefore, before making a decision on refinancing your home, you should consider whether a refinance will be worth your money. 

What is refinance?

Typically, homeowners refinance their home mortgages when the interest rate drops. When you refinance your house, your current mortgage will be replaced with a new loan. That new mortgage loan will have a new term, interest rate and monthly payment.  

What are the reasons to refinance?

There are multiple reasons for homeowners to refinance their home. You may want to refinance when the mortgage interest rate is lower than your current mortgage rate. By refinancing your home loan with a lower interest rate, you can save a lot of money on the interest payments of the overall mortgage loan. Also, you may want to refinance to cash out from your house equity for home improvement and for other investments to improve your financial situation. Furthermore, you may want to refinance to change your current mortgage loan to another mortgage. For instance, you may move your mortgage from adjustable rate mortgage (ARM) to a 30 fixed rate mortgage or vice versa. 

What is the closing cost to refinance?

The cost to refinance varies depending on different states and counties.  According to the U.S Department and Urban Development (HUD) data, the average closing cost to refinance is $5,000 or 2%-6% of your loan amount. You can estimate the costs of refinancing by using the refinancing cost estimator to have an idea how much you will need to pay for the cost. 

What to consider before refinancing?

Before refinancing your house, you should consider multiple factors.  Note that when you refinance, you will have a new loan with a new term, interest rate, and monthly payment. You also have to pay for closing costs on refinancing. In addition, you should consider other benefits and drawbacks of refinancing. 

Comparing refinancing closing costs and savings on mortgage interest payments

You should do an estimate of the cost of refinancing and the savings on mortgage interest  payment when you refinance. You can use the refinancing calculator to estimate how much you can save on refinancing your mortgage. Then, you can compare the cost and savings to see whether it is worth refinancing or not. 

For instance, by using the refinancing cost estimator, you can get an estimate how much you need to spend to refinance. Divide the amount in terms of monthly payments. Then, you can figure out how much you can save on monthly interest payments by using the refinancing calculator. Compare the monthly cost and savings amount to see if it is worth refinancing.  

In addition, it is important to consider how long you will plan to stay in your house before you decide to refinance. For example, let’s say you spend $5,000 for closing costs to refinance your home. It may take 4 years to recoup the cost. However, if you plan to move out and sell your house 2 years after refinancing then, it may not be worth the refinancing cost. 

Cashing out  your mortgage equity

You want to cash out from the house equity for home improvement or for other investments to improve your financial situation. Cashing out from your house equity may be an option to generate a big amount of money to fund your project. However, you need to consider its good side and drawbacks. 

Refinancing to improve your home

Home improvement can increase your home value. However, you may want to improve your home in a way that costs less. According to the 2021 Cost vs Value report, you can recoup approximately 94% of the cost on garage door replacement, 92% on manufactured stone veneer, 72% on minor kitchen remodel, 67% on window replace, 58% on bathroom remodel and more when you resell the house. 

The loan amount that you can get from your home equity may vary.  It depends on how much equity you have in the house. Most lenders require that the total loan amount including the mortgage remaining balance plus the new loan you borrow cannot be above 90% of the house value before any improvements. For instance, your home loan is $400,000. Your loan remaining balance is $300,000. Then, the lender may lend you up to $60,000 ( 60,000+300,000 = 360,000 or 90% of $400,000). 

Refinancing to buy another property

Should you refinance and use the house equity to buy a second house? You can build a larger equity by taking the advantage of leverage of mortgage loans to buy a second property. You can live in one house and rent the other one. However, you need to plan for it carefully. For instance, you need to plan to avoid mortgage loan payment defaults. Payment defaults will adversely impact your credit and in the worst scenario, the lender will take over the property. Also, you should have emergency savings to cover all expenses in cases of loss of income due to losing a job, getting sick, or vacancy of rental properties, major repairs and more. 

Furthermore, the amount of money that you can get depends on your home equity, credit score, and loan-to-value ratio.  Most lenders may not lend you more than 75% to 85% of the value of your home.  

Refinancing to invest in stocks

Should you refinance and use the equity to invest in stocks? The compound growth or exponential growth of  stocks may be very attractive. However, experts suggest that you should not use borrowed money to invest in the stock market to avoid the risk of losing money due to stock volatility. The worst case situation is that you may lose your home. Therefore, you should be extremely cautious when you plan to use home equity to invest in stocks. All investments carry risks. So, before making any decision, you always need to do research, make plans, make calculations and comparisons, and weigh all the bad and good sides of your investment plan. Invest wisely and avoid losing your money.   

New loan term on refinancing your house

When you refinance your property, you are essentially paying off your previous loan and taking on a new loan with new rates and terms. This could mean that the time to pay off your mortgage could be longer or shorter based on the term of the new loan.

Let’s say your current mortgage has a 30 year fixed-interest rate.  You want to pay off your mortgage faster and become free of mortgage debt. So, you plan to change your 30 year fixed-interest rate to an adjustable rate mortgage (ARM) loan. You take advantage of the lower interest rate and use more of your monthly payments to go towards your principal. Note that the ARM interest rate may start with a lower rate to attract borrowers. However,  the interest rate of ARM loans will fluctuate up or down due to the market conditions during the period of its term. Then, you will have to pay a higher or lower interest payment due to its fluctuation.  In addition, When refinancing with a shorter term loan, you may need to pay a higher monthly payment because the shorter term mortgage loan includes a larger portion of principal plus interest payment. 

On the other hand, let’s say your current mortgage is an ARM loan. You plan to change it to a 30 year fixed-interest rate loan. The interest rate of a 30 year fixed-interest rate mortgage loan will be the same over the life of the loan. You will not have to worry about the changes of interest rates if you move from an ARM loan to a 30 fixed-interest rate mortgage. However, you have to pay for your mortgage longer. 

How to refinance your house?

When the interest rate is low, It may be a good time to refinance your home. However, you should consider multiple factors in order to make the best decision. 

Seeking loan estimates

After considering the pros and cons, let’s say you decide to refinance your home. You should reach out to multiple lenders to explore the best  option for your situation. According to Freddiemac research, borrowers can save an average of $1,500 on the overall life of a loan if they seek an additional loan quote. That saving can be $3,000 if borrowers get 5 loan estimates.  Therefore, you should shop around and compare costs amongst lenders so that you can pick the best one. Ask lenders for detailed loan estimates which show  specific loan amounts, the interest rates and fees. You can use the comparison worksheet to make a comparison and pick the best deal amongst multiple lenders. In addition, you should have many questions and request answers from the lenders on the loan before you make a commitment. 

Your loan amount will depend on your home equity, credit scores and loan-to value ratio. Also, an appraisal on the home value may be needed based on the  loan amount. If you have a FHA, VA or USDA loan, the appraisal may be waived. You need to talk to your lender and check if the lender needs to do an appraisal for refinancing. 

Preparing for an appraisal on your home value

If an appraisal on your home value needs to be done for refinancing your house, the lender will have a professional come to your house to do the appraisal. The appraisal report with a new home value will be issued. That new home value may affect the loan amount that you want to borrow from your house equity. Therefore, you should get your home cleaned, organized before an appraisal. You do not need to spend a lot of money for it. But you should get your house ready and hope that the appraisal value will be as high as it can be. If you have improvements such as paintings, bathroom remodel, kitchen remodel, roof changes and so on, it is very important to let the appraisal professional know. House improvements will increase your home value. 

How to refinance without an appraisal?

Most lenders require you to have an appraisal to refinance your home mortgage. However, an appraisal before refinancing may not be required in some cases depending on multiple factors such as your home equity, cash-out option and more. Each type of loan has its own standard requirements. Therefore, you need to talk to your lender to figure out the option for your specific situation.

In addition, the lender may waive an appraisal if you have a FHA, VA or USDA loan. You need to meet certain requirements to waive the appraisal for refinancing on these loans. Note that you still have to pay for refinancing closing costs. Refinancing closing costs may be paid out upfront or rolled into your new loan.

FHA streamline refinance

Let’s say you plan to refinance your current FHA insured mortgage to another FHA-insured mortgage. Then, an appraisal as well as credit score check is not required. However, you need to meet other requirements. For instance, you should not have any late mortgage payment in the past 6 months or 1 late payment in the last one year. At least 6 month mortgage payments should have been made before starting a new refinancing application. In addition, you may not take above $500 out of your mortgage if you refinance using streamline refinancing. However, if you refinance your current FHA insured mortgage to another FHA-insured mortgage within 3 years, you may get a credit refund which will significantly reduce your upfront mortgage insurance premium.

VA streamline refinance 

A VA streamline refinancing is referred to as a VA Interest Rate Reduction Refinancing Loan (IRRRL). Lenders may not require an appraisal for refinancing your VA IRRRL. You may qualify for a VA IRRRL with a lower interest rate monthly payment if you plan to refinance your current VA-backed loan to another VA-backed loan. A VA-backed loan is a portion of loan which you get from a private lender that is guaranteed by the VA.  In addition, you must meet certain requirements to qualify for a VA IRRL. For instance, you must live in the home that you refinance. At least 6 month mortgage payments should have been made before starting a new refinancing application. And, you may not take the cash out option. 

You may be eligible to cash out from refinancing on your VA-backed mortgage loan if you meet certain requirements such as credit scores, income and other requirements.  

USDA streamline assist-refinance

No appraisal, credit check or loan-to-value ratio is required for USDA streamline assist-refinance. However, you cannot cash out from your home equity when you refinance. Also, you must have no late mortgage payment in the past 12 months and should also meet other requirements. 

Questions and Answers – Refinancing a home: planning before refinancing

1.  When should you refinance your mortgage loan?

Typically, you want to refinance when the interest is lower. Also, you refinance your home mortgage for several reasons such as to take advantage of a lower interest rate, to reduce your monthly mortgage payment, to cash out for home improvements or financial improvement or to change one mortgage to another mortgage. However, you need to research, make calculations and compare amongst refinancing options to see whether it makes financial sense to refinance your home. 

2. How often can you refinance your home?

You can refinance your mortgage loan as many times as you want if you will not cash out from your home equity. Again, you should consider if refinancing does make financial sense to your specific situation. If you cash out from your home equity, you may have to wait 6 months from the time you close on the loan to when you refinance your current loan to a new loan. Also, you should check if your loan has a pre-payment penalty before refinancing.

3. Do you have to work with the same lender of the original loan when you refinance your home?

You do not have to work with the same lender of your original loan to refinance your current home loan. You should reach out to lenders for multiple loan quotes and pick out the best deal. 

4. Can you refinance without any closing cost?

You have to pay closing costs on refinance your mortgage loan. You can pay the closing cost upfront or roll into your new loan. Generally, refinancing closing costs are rolled into borrowers’ new loans when no costs are paid upfront for closing new loans. 

5. Can you refinance your conventional loan to FHA mortgage loan?

You can refinance your conventional loan to FHA mortgage loan and vice versa if you meet  certain loan requirements. You should talk to your lender to choose the best option for your situation. 

Conventional loans offer a larger loan amount than FHA loans do. Therefore, you may be able to cash out a larger amount from your conventional loan than the FHA loan. However, the interest rate of FHA home loans is generally lower than the conventional loan’s interest rate. In addition, you should consider the cost of  the FHA loan’s upfront mortgage insurance premium, the conventional loan’s private mortgage insurance (PMI) and its closing cost on refinancing your home.

6. Will your credit scores be affected by multiple mortgage inquiries?

When you work with multiple lenders to get the best deal, lenders may pull your credit report to understand your overall financial situation. As a result, your credit scores may be affected. However, a mortgage loan inquiry is usually considered better than other loans like credit card loans. So, your credit scores may be affected during the short period of time when you have to work with multiple lenders.