So, once you get your home loan, you’re done forever, right? Well, not usually. You are certainly able to stay with your existing mortgage until it’s paid off. But, during that time, markets can change. Your financial needs could change. This is why refinancing is so popular. Did you buy your home four years ago, and rates are much lower today? Do you have equity in your home you want to capitalize on? These are just a couple questions that can lead to a refinance.
There are essentially two basic types of refinance: Rate and Term, and Cash Out. Rate and Term refinances are transactions when the new loan is intended solely to pay off your current mortgage and get you into a new loan at either a new (hopefully better) rate and/or term. A Cash Out refinance in basically what it says: you get cash in hand at closing.
A Cash Out refinance is a good option for you if you need some additional cash for a variety of reasons, but perhaps credit cards, consumer/bank loans, or a HELOC is not what you’re looking for. A Cash Out home loan still accomplishes the goal of paying off your current mortgage and putting you into a new loan, at hopefully a better interest rate and/or term. But in addition, you can monetize the remaining equity in your home and get cash back to you to use as you wish. Often times, a cash out refinance is used to either fund home improvements, or as a debt consolidation tool. In some cases, if the goal is to pay off other debts using your home’s equity, the lender may require that the funds be paid directly to the specified creditors rather than to the borrower, thereby ensuring that the funds are used as designed (which also reduces the credit exposure and DTI of the borrower, theoretically). Otherwise, cash is often paid directly to the borrower three days after closing, known as the rescission period. A key factor is that a refinance is not considered cash out unless the amount of cash paid to the borrower is over 2% of the total loan amount. This is important, because cash out loans often have higher interest rates and possibly even differences in available terms.
Refinancing your mortgage is not too different from the process when you acquired a mortgage to buy your home; it’s just for a different purpose! For the most part, all of the same qualification requirements will remain. Credit score and history will be evaluated, income, employment, amount you wish to borrow, home value, etc. PMI is still a factor (see our page about PMI to learn more about this), so how much you’re borrowing vs. your home’s value will be a major player in determining the terms available to you on a refinance.
Another factor to consider is that you will have a new set of closing costs when you refinance. Some lenders will work with you and do a direct “streamlined” refinance if they have such a program, which usually saves you some money, as well as the potential hassle of finding a new loan, going through the whole approval process, etc. These are sometimes referred to as loan modifications. But if that type of process is not available, then you will typically incur similar costs to any other normal mortgage loan closing.
When you refinance your home loan, you can either pay the closing costs out of pocket, or you can try to roll the costs into the new loan. If you roll them in, you need to have appropriate equity to cover them, as it essentially raises your loan amount, with the excess funds after paying off your current mortgage going towards your costs. These excess funds are considered “cash out” as it is cash being paid out to you or on your behalf that is above and beyond the amount needed to pay off your existing mortgage. But so long as the total cash out is under 2% of the total loan amount, it will still be considered a rate/term refinance.
Refinancing can be a very profitable endeavor when approached carefully and with much thought. If you can get a much lower interest rate on your loan than you have now, then it could be a no brainer in terms of monetary savings. Always include the closing costs in the equation, though. If reducing to a lower interest rate will only save you $10 per month in payments, but will cost you $2,500 in costs, it may or may not be worth it. In terms of costs, a good rule of thumb is the three year rule: If you plan on staying in your home for many more years, will your monthly savings make up the cost of the refinance within 36 months? In the example mentioned above, saving $10 per month equates to $360 in savings over the course of three months. This does not offset the $2,500 costs required to make the refinance happen, so many would say it was not worth it, and actually cost you more in the long run. Now, if your new loan will save you $80 per month, then those savings will add up to $2,880, which will offset the closing costs, and then some, in three years.
If you’re looking to refinance your home, whether a Rate and Term refinance or a Cash Out refinance, feel free to complete our information form to the right of your screen, and we’ll get you in touch with a lender or broker who can help walk you through the process!