Why refinance your mortgage?
There are multiple reasons to refinance your mortgage. People usually refi to save money, either in the short run or the long run, but there are other rationales for refinancing. Here are some common goals that can be accomplished with a refi:
Lower the mortgage rate. If mortgage interest rates fall after you get your original loan, you may be able to refinance to a lower rate. This can result in smaller monthly payments.
Shorten the loan term. Refinancing from a 30-year mortgage to a shorter-term loan (15 or 20 years, most commonly) might increase your monthly payment even with a lower interest rate. However, it decreases the overall interest you pay over the life of the loan and allows you to pay off your mortgage sooner.
Get rid of mortgage insurance. When you buy a home with a conventional loan and a down payment of less than 20%, you have to pay for private mortgage insurance. Refinancing is one way to stop paying private mortgage insurance on a conventional loan; and if you have an FHA loan, it’s the only way to get rid of FHA mortgage insurance.
Change your loan type. Rather than enduring an uncertain interest rate with an adjustable-rate mortgage, you might refinance to a fixed-rate loan so you don’t have to worry that the rate will rise. If you originally bought your home with an FHA loan and you could now qualify for a conventional loan, you might make that switch.
Access equity. With a cash-out refinance, you borrow more than your current loan balance and take out the difference in cash. A cash-out refinance is a popular way to pay for major home improvements.
Add or remove a borrower. Because changing who’s responsible for paying the mortgage changes the terms of your agreement with the lender, you’ll need to refi if you want to put a new borrower on the loan or take someone off the mortgage, for instance, after a marriage or divorce.
Lower your monthly payment. Refinancing back to a 30-year mortgage can give you smaller mortgage payments, because you’re stretching out your payments over a longer period of time. But a longer loan means more interest, too. If your main reason for refinancing is difficulty making your mortgage payments, you may want to consider other options.
Common refinance requirements
In order to qualify for a mortgage refinance, you will need to meet the criteria set by your lender and loan program. These will vary, but here’s an idea of what you can expect.
Credit score. A higher credit score can help you secure a lower refinance interest rate. Government-backed refinance loans typically have lower credit score requirements than conventional loans. But lenders are permitted to set higher minimums if they choose. If your credit could use some polishing, you may want to work on it before applying for a refinance.
Debt-to-income ratio. Your debt-to-income ratio is the portion of your gross income that goes to paying your debt, including your mortgage. Many lenders require a DTI below 36%. You can refinance a mortgage with a higher DTI, but you may pay a higher interest rate.
Home equity. Your home equity is the value of your home minus what is owed on the mortgage. The amount of equity you need to refinance varies by lender and type of mortgage, but 20% equity is a common requirement.
Refinance wait period. While you can refinance as often as you want, some lenders require a “seasoning” period between loans. With a conventional cash-out refinance, for instance, you will have to wait six months. If you are refinancing an FHA, VA or USDA mortgage, the waiting time varies between six and 12 months.
Types of mortgage refinances
Whether you’re looking to refinance a conventional or government-backed mortgage, there are generally four types of refinances:
Rate-and-term refinance. A rate-and-term refinance is exactly what it sounds like: you refinance your mortgage to reduce the interest rate, alter the length of the loan, or both.
Cash-out refinance. A cash-out refinance is when you replace your mortgage with a new one for more than your current loan balance. You receive the difference as cash that can be used for home improvements or other financial responsibilities. There are conventional, FHA and VA cash-out refinancing options.
Streamlined refinance. The FHA, VA and USDA offer streamlined refinancing options that may allow you to skip the usual appraisal and credit check, saving you time and money. The FHA streamline and VA IRRRL both require that the refinancing result in a financial benefit: either a reduction in your monthly payment or interest rate.
Renovation refinance. A renovation refinance loan works somewhat like a cash-out refinance, in that you take out a larger loan than what you previously owed. The proceeds from the refi go toward fixing up your home. With some renovation refinances, like the FHA 203(k) loan, the lender directly pays your contractor. Renovation refinances sometimes allow you to borrow against the value of the home once the upgrades are completed rather than its current value.
Choosing a refinance lender
Whether you’re looking for the reach of a traditional bank or the personalized service of a credit union, always shop multiple lenders and compare the interest rate and terms each lender offers. Even though it might be easy to refinance with your current mortgage lender, it may not offer the best deal.
Just like when you bought your home, your lender is required to provide you with a Loan Estimate after you apply to refinance. Compare fees listed under the “origination charges” on the document. If you are not comfortable with a fee, try to negotiate for it to be removed or reduced.