Refinancing a Mortgage – Your 2021 Guide
Mortgage refinancing is when you pay off your existing mortgage by obtaining a new loan. With the existing one paid off, the new loan takes its place, which you then pay in monthly installments.
But it isn’t as easy as it sounds; Did you know that the costs could be 3-5% of the loan amount, which could be $2,000-$5,000?
The COVID-19 pandemic has caused the mortgage rates to lower to the 3’s from the 4’s of 2019. If you want to refinance, now is the best time before the rates rise again in mid to late 2021.
This article walks you through everything you need to know about refinancing, its types, pros, and cons, mistakes to avoid, tax implications, etc.
What Is Refinancing a Mortgage?
Refinancing is a process by which you obtain a new loan either to pay off the current one or to consolidate the debt, on the condition that the new interest rates are lower with better terms. With refinancing, the borrowers negotiate a new loan agreement with lower monthly payments, a better monthly payment structure, and change the loan type.
Types of Refinancing
No two refinance loans can be the same. They vary in many ways depending on their debt, mortgage, and also the reasons for refinancing. Having said that, there are three types of refinancing loans.
- Rate-and-Term Refinance
- Cash-out Refinance
- Cash-in Refinance
With a rate and term, the loan amount is equal to the mortgage on the home. The homeowners can pay off the original mortgage and get a new mortgage with an altered loan term or mortgage rate, sometimes even both. You can either:
- Lower the loan term and maintain the interest rate
- Lower the interest rate and maintain the loan term
- Lower the interest rate and the loan term
The aim is to reduce the monthly payments and save money. So, you choose whichever option works the best. However, if you shorten the length of your loan, the monthly payments will be higher.
With a cash-out refinance, you tap into the equity in your home. Home equity is the difference between the mortgage amount and the value of your home. The new loan you get is higher than the mortgage.
You get to pay off what you currently owe on your home and cash out the excess amount. In the case of a debt consolidation refinance, the cash-out will be directed to the creditors.
Depending on the current market, you may be able to get a lower interest rate or shorter term, whatever you may desire.
With a cash-in refinance, the homeowners can pay down or close out the existing mortgage. The lower the money you owe to the bank, the lower your interest rate. You can also have a shorter loan term too.
There are various reasons why homeowners prefer a cash-in:
- Lower interest rates and LTV ratio
- Cancel mortgage insurance premium payments
Pros and Cons of Refinancing Your Home
Refinancing the home allows homeowners to take a breather in times of economic uncertainty. However, you are essentially taking a new mortgage loan with better terms with a refinance than your current loan. But it need not be so since it depends on various other factors.
It pays to understand the process, evaluate the pros and cons before choosing to refinance.
- Low monthly payment
- Lower interest rate
- Save your interest in the long term by reducing your loan term.
- Convert from an adjustable-rate mortgage to a fixed-rate mortgage and enjoy the predictability and stability it offers. Locking the rate helps to protect against rising interests.
- A cash-out refinance helps you pay off the loans and saves you a chunk of money for home improvement projects.
- Homeowners whose principal is paid off will not be required to pay private mortgage insurance.
- Lowering monthly mortgage payments resets the length of the loan.
- Shifting to a fixed-rate loan prevents you from taking advantage of lowered interest payments in the future.
- Lowered loan term will increase the monthly payment.
- Cash-out refinance will cost you more interest throughout the life of the loan.
To Refinance or Not to Refinance
Refinancing your loan will save money, especially when the interest rates are low. You can also build home equity and pay off your mortgage. But are these worth obtaining a refinance?
Here are a few pointers to consider before making a smart financial decision:
- Can you lower the interest rate by one-half to three-quarters? If so, you can reduce your mortgage payment substantially.
- Your monthly savings should balance the cost of refinancing.
- Do not refinance if you plan on moving any time within the next two years. You cannot recoup the cost within this timeframe.
- Are your proceeds from refinancing going towards retirement savings or on a spending spree? If it’s the latter, do not refinance.
- Are you cashing out to renovate your kitchen or bathroom? Doing both can increase the value of your home.
Best Time to Refinance Your Mortgage
Your mortgage loan officer has a monthly and a quarterly target to meet. Not everyone can keep up with their targets and will be desperate by the end. As such, you will be able to score better terms on your mortgage.
Considering the above, the best time of the month will be the last two weeks of every month. And the best time of the year for refinancing your mortgage will be the last month of every quarter, March, June, September, December.
The Refinance Application Process
The mortgage refinance process can be pretty intimidating, but they aren’t different from applying for a home loan. Here’s a quick overview of the application process:
- Make sure your credit score is high enough for a new loan.
- Compare different mortgage loans to find better loan options.
- Gather all the necessary documentation.
- Apply for a mortgage refinance and ensure that you do not make any mistakes.
- Your lender takes over starting with the appraisal process. You are responsible for the cost of the process, which is $300 and $400.
- Your refinance loan goes through an underwriter who check for the mistake, missing documents, and such.
- Lock your interest rate so that you get the rate specified in the approval letter. Make sure this happens six days before the closing process, or the closing costs can increase.
- You can close the loan in the presence of a lawyer or notary public.
- The three days right of cancel period comes into effect, after which the lender will pay off your old mortgage, and the new refinance loan will be in effect.
Documents Needed for Refinancing a Mortgage
Your lender might require these documents before you qualify for a refinance loan.
- Pay stubs (for the last 2-3 months)
- W-2 and/or 1099-MISC forms (for the past two years)
- Tax returns
- Statement of assets (including bank statements, retirement accounts like 401k, bonds, stocks, mutual funds, life insurance policies, etc.)
- Statement of debts
- Homeowners’ insurance
Mortgage Refinance Requirements
The first step in the refinancing process is to make sure you are eligible for loans and be prepared for the lengthy process. Here are the minimum requirements to apply for a mortgage refinance:
- You may need six months or a year after you own a property with your name on the title to apply for a mortgage loan.
- An adequate credit score of 620 or higher.
- A 20% home equity is the minimum requirement for refinancing.
- Your debt-to-income ratio should be 50% or lower. If you have a higher DTI reduce your loans before applying for a refinance.
- Ensure that you can afford the closing costs. Some lenders may roll it into your new loan.
Costs of Refinancing a Mortgage
A refinance comes with costs and fees that you would have to pay beforehand. So, it pays well to consider how much the refinance would save over the years:
- Origination fee: Up to 1.5% of the loan amount
- Application fee:$75 to $500
- Credit report fee:$30 to $50
- Home appraisal:$300 to $400
- Home inspection:$300 to $500
- Flood certification fee:$15 to $25
- Title search and insurance fee:$400 to $900
- Reconveyance fee:$50 to $65
- Recording fee:$25 to $250
Refinance Closing Costs: Lower and Avoid Fees
The goal of refinancing is to be able to have spare cash for expenses. But what if you cannot afford the fees?
Here are a few ways by which you can reduce the costs:
- Improve your credit score and debt to income ratio.
- Negotiate the fees if possible, especially if you have good credit and stable income.
- If you go with the same company as your mortgage, you can save money on title fees.
- Think twice about paying for mortgage points. With good credit, you are already eligible for a low-interest rate.
- You can also avail of third-party services for a home inspection, title, etc., for inexpensive options.
- Your lender may waive appraisal fees if your home has been appraised recently.
However, few companies may also offer no costs. But in truth, the lender rolls it into the mortgage loan amount spreading it over the life of the loan.
Pitfalls to Avoid When Refinancing a Mortgage
Most homeowners look for low interest in mortgage refinancing. But finding and availing one is not as simple as that. Here are a few mistakes you might want to avoid when looking to refinance a mortgage.
- Not shopping around for better interest rate: Even half a percentage reduction can save thousands in the long run.
- Not looking into the terms: Low mortgage interest rates can hide high fees. Ensure you check the closing costs before finalizing the refinance loan.
- Not Saving enough: To make the refinance worthwhile, you need to make sure that the new interest rate is at least a full percentage lower than the current one.
- Refinancing frequently: In the chase for lower interest rates, homeowners end up refinancing. With every new loan, you have further fees and an increased loan balance. This cycle may take years to break even.
- Not taking time to review the documents, including the good faith estimate: Unscrupulous mortgage lenders can add hidden fees to the final documentation. Make sure it matches with the good faith estimate.
- Cashing out home equity: When you take too much out of your home equity, you leave yourself exposed to financial troubles when the real estate prices fall.
- Extending the life of your new loan: In the search for a lower interest rate and low monthly payment, your repayment term can increase.
- Agreeing to prepayment penalties: There is no need for a refinance to have a prepayment penalty for more than 3-5 years. It is a way for your lender to make up for the “no-cost” refinance.
Misguided Reasons to Refinance Your Mortgage
Even with a lower interest rate, refinancing may end up costly for a few due to their closing fees. While everyone has a reason to refinance, here are a few reasons for which you should not refinance your home:
- Consolidating your unsecured debt like credit card debt into your secured debt; When you miss the monthly payment, you will end up losing your home.
- Do not refinance to save up for a new home. If you plan to move within two years of mortgage refinancing, you are not saving anything at all.
- Cashing out for investing in a stock market is not a good idea even when it seems stable. But if you are looking to build your emergency fund or renovate your home.
- Switch from ARM(adjustable-rate mortgage) to fixed-rate loan only if you are not planning to sell anytime in the near future.
- If you want to refinance purely to take advantage of the no-cost refinance, the fact is there is no such offer. Mortgage lenders wrap the costs into your loan.
Appraise Your Property Before Refinancing
A home appraisal is an essential step in your refinance process where an appraiser gets you an estimate of how much your home is worth at a current point in time.
They start by taking pictures of every room in the house, along with the exterior. Then by comparing your home to the prices of the other homes in the neighborhood, they finalize a price. Your lender considers this as an upper limit for your home loan.
A low appraisal is a serious problem since it lowers the value of your home, whether you are refinancing or selling. Here are some ways by which you can increase the chances of a better appraisal:
- Improve the curb appeal by planting new plants and mowing your lawn.
- Declutter your home and put away everything in its designated place.
- Ensure that all the appliances and light bulbs work.
- Touch up the paint if needed. Or repaint if possible.
- Add small upgrades to increase the home value.
However, you may not always need an appraisal for refinancing. In case you have a VA or a USDA loan, an appraisal may not be necessary at all, and you can refinance up to 120% of your loan value.
Impact of Refinancing on Property Taxes
Refinancing doesn’t affect property taxes in any way. But if you are in a neighborhood with increasing property rates, your appraiser may value your home to be much higher than your earlier assessed value. While this doesn’t increase the taxes in itself, it is an indication that the taxes may increase in the future.
Tax Implications of Refinancing Your Mortgage
While refinancing a mortgage can be a money-saving move, it has profound implications for your tax. Refinance loans are viewed as debt restructures and would not enjoy the same tax benefits as your original mortgage.
For a loan the originated before Dec 15, 2017, the interest will be deducted for a $1 million loan balance. In the case of loans after the cut-off date, the loan balance should be $750K for joint filing and $500k for married filing separately.
Another point to note is that there will be less rate to deduct when refinancing to a lower interest rate during the tax period.
For example, if you pay 5% interest on a 30-year loan and refinance to a 15-year fixed-rate mortgage with a 3% interest, you can see a 40% reduction in interest costs.
While you save money by paying less interest, you would not be able to claim much during the tax period.
Claim Your Refinance Tax Deductions
You can claim your:
- Mortgage Interest
- Discount Points
- Closing Costs
Concerning the discount points and the costs, you can claim these as deductible through the course of your loan. For example, if you have spent $5,000 and $15,000 on these expenses for a 30-year fixed-rate mortgage term, you can deduct $250 and $500 every year from your taxes.
Coming to the mortgage, you can claim the deduction for the interest paid the same year. For example, if you paid $1000 in mortgage rates for the year 2021, you should deduct $1000 from your taxes for the same year.
The Effects that Refinancing a Mortgage Have on Credit Scores
Mortgage refinancing can affect the credit scores, albeit temporarily, in a couple of ways:
- Credit Check: With every refinancing, your lender will do a credit check to check your credit standing and history. This is called a hard inquiry which causes your score to drop slightly and momentarily.
- Applying for multiple loans over a long time period: Every new mortgage loan that you apply for is likely to make a hard credit inquiry every time. And with every check, your credit score can negatively affect your score. Ensure that you place the inquiries within a 14-45 day period to minimize the hit to the credit.
- Account Closure: Every loan that you close can also lower your credit score. But if the loan is in good standing, the hit to your credit score might be less.
Refinancing makes sense if you are looking to lower the interest rates and mortgage payments. But you may want to research and shop around for better options. Not every lender has the same rates, terms, and costs for closing.
Refinancing is an easy way of hitting your financial goals, but only if you are careful about the refinance process and the lender. With the rates at a record low, you may want to commit before they rise again now that the world is returning to normal. But make sure you do not have any plans to move or sell until you break even.
Priority Lending, LLC has been providing mortgage loans and helping people like you fulfill their dreams since 1997. Contact one of our loan officers today to get started on refinancing your mortgage.
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