What does it Mean to Refinance?


What does it Mean to Refinance?

By: Greg McKinney Mineola Texas

 You’ve likely heard of many people refinancing over the last year. With interest rates at rock bottom levels, most people took advantage and refinanced, but what does it mean and is it worth it when rates increase?

 Even though interest rates are higher, millions of people are still refinancing. While lowering your interest rate is a great reason to refinance, there are other reasons too.

 What is a Refinance? 

When you refinance your mortgage, you pay off one mortgage with a new one. It’s the same process as when you bought your home. You must prove you can afford the loan and have the necessary qualifying factors. 

Homeowners can refinance to lower their interest rate, change their loan term, or take equity out of their homes. 

How Refinancing Works 

When you refinance, everything happens behind the scenes, just like when you bought your home. Your lender orders a payoff to make sure your new loan amount is high enough to cover your existing loan.

 You provide the lender with the same qualifying documents including:

·       Paystubs for the last 30 days

·       W-2s for the last 2 years

·       Tax returns for the last 2 years (if you’re self-employed)

·       Bank statements for the last 2 months

·       Proof of employment

 Lenders underwrite your loan to make sure you meet the loan qualifications. If you do, they pay off your existing mortgage with the funds from the new loan. You then pay the new lender each month.

 The Types of Refinances 

There are three main types of refinances. While you can use just about any loan program to refinance, each has options including: 

Rate/Term Refinance 

The rate/term refinance is simply to change your loan’s rate or term. For example, if you have a higher interest rate than you can get today, you might refinance. You can also use this program if you want to change your loan’s term from an ARM to fixed-rate or a 30-year to a 15-year as a couple of examples.

 The point of refinancing with a rate/term refinance is to save money either monthly or over the life of the loan. For example, if you refinance into a shorter term, your monthly payment will be higher, but you’ll save thousands of dollars in interest over the life of the loan.

 Cash-Out Refinance

 A cash-out refinance allows you to use your home’s equity. Your equity is the difference between your home’s value and how much you owe on your mortgage. Say for example your home is worth $400,000 and you have a $200,000 mortgage. This leaves you with $200,000 in equity.

 Most lenders allow you to borrow up to 80% of a home’s value minus any outstanding loans, leaving 20% of your equity untouched for leverage.

 With a cash-out refinance, you borrow more than you currently owe on your mortgage. You receive the difference as cash 3 days after you close (all refinance loans have a three-day right of rescission).

 You can use the cash however you want. Some common ways borrowers use them include:

·       Home improvements

·       Emergency funds

·       To invest elsewhere

·       To consolidate debt

·       Cover major expenses 

A cash-out refinance may have slightly higher interest rates because of the higher risk, and/or slightly tougher qualifying requirements. 

Like when you bought your home, the bank uses the home as collateral. If you default on the payments, they can foreclose on the home so make sure you don’t borrow more than you can afford. 

Cash-In Refinance 

A cash-in refinance is a way to pay your mortgage balance down and refinance to get more favorable terms. 

Rather than receiving cash at the closing, you bring cash to the closing for a cash-in refinance. You are paying down the loan balance so there is a lower balance to refinance. This usually results in a lower payment and/or better interest rate because you’re financing a lower amount. 

How to Qualify to Refinance 

Just like when you bought your home, you must qualify to refinance. You must prove to lenders that you can afford the loan and have a good credit history that shows responsible use of your finances. 

Just like when you bought your home, lenders will look at the following. 

Credit Scores 

Your credit scores are the first things lenders look at when you apply for a mortgage. They want to know that you have a high enough credit score to demonstrate financial responsibility. On average, you need a 660-credit score or higher for a conventional loan. If you have a lower credit score, you might qualify for an FHA loan

Debt-to-Income Ratios 

Lenders also closely evaluate your debt-to-income ratios. This is the comparison of your monthly debts to your gross monthly income. ideally, your total debts shouldn’t exceed 43% of your monthly income.

 Your DTI includes the following debts: 

·       The potential mortgage payment (principal, interest, real estate taxes, homeowner’s insurance)

·       Car payments

·       Student loan payments

·       Personal loan payments

·       Minimum credit card payments

 The lower your DTI is, the easier it is to get approved, especially for a cash-out refinance.

 Loan to Value Ratios

 Lenders also look at how much you’re borrowing compared to your home’s value. For a cash-out refinance, you’re limited to an 80% LTV. For rate/term or cash-in refinances, though, you can have a much higher LTV.

 However, the lower your LTV is, the lower the interest rate a lender may offer you. A lower LTV means a lower risk of default for lenders.

 Final Thoughts

 If you’re thinking about refinancing, there are many ways to go about it. Think about why you want to refinance – what are your financial goals? Next, determine what programs you qualify for and if you can afford the new payment.

 Keeping your credit scores high and your debts low will help you achieve your personal financial goals when refinancing your mortgage. Like any loan, shop around to make sure you get the most favorable terms for your loan so you can reach your financial goals with one of the largest investments you’ll make in your lifetime – your home.

Greg McKinney Mineola Texas



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