There are various reasons why families choose to refinance their mortgage. Data from Statista indicates that the most common reason is to pay off debts or bills. Other families do it to build their savings.
But before you choose to refinance your mortgage, you must first understand how mortgage rates are determined and the variables involved. In his article ‘Buy Versus Rent’, Yoreevo’s real estate analyst James McGrath elaborates on the two components of a standard mortgage, namely principal and interest payments. In a nutshell, the first refers to the actual loan while the interest refers to the lender’s reward for loaning the money. Most mortgages are structured so that your first payments are usually the interest plus a little percentage of the principal. As you go through your monthly payments, the percentage of your amortization that goes into paying the capital increases. If your current mortgage is an adjustable rate mortgage (ARM), it means that your interest rate can get higher every year. Even if your ARM seems lower than the average fixed mortgage arrangement, it can increase according to market changes and your income may not be able to keep up.
This is when refinancing can be beneficial. You can refinance your mortgage and take on a fixed rate mortgage. With interest rates reaching all-time highs, according to Diana Olick of CNBC, refinancing for a fixed rate conversion may be a sound financial strategy. If you come across another lender that offers lower rates, a shorter term, or both, refinancing is a wise choice.
A word of caution though, as refinancing usually costs 3% to 6% of the loan’s principal. We’re talking bank fees, attorney fees, appraisal charges, and insurance. If you’re not planning to stay in the property for more than five years, it may not be worth paying the considerable sum.
And if you’re planning to refinance a mortgage for reasons other than the ones mentioned, you might want to reconsider. While refinancing to consolidate your debts is not a bad plan, tapping equity for another expense certainly is, especially if it doesn’t have any future income returns. For instance, you might refinance mortgage to be able to get a car, but it is an asset that just entails more expenses. On the other hand, a college education can be a great investment. Still, using your equity for any of these can be risky, so it would be best to look for other sources and use your equity as a last resort.
Before refinancing a mortgage, there are also things you need to consider, such as your credit score. You need to get a loan pre-approved before getting a new loan. The typical bank loan requires a score of 620 while a Federal Housing Administration loan can be acquired with a score as low as 540. Higher credit scores can mean enormous savings and better terms. Consider getting your score from the three credit bureaus rather than just one or two.
Once you’ve decided to refinance, the next step is to sort your requirements. Different lenders will ask for different documents, but the usual list includes pay stubs (proof of income), tax returns and W-2s (usually for two years), credit report, statements of outstanding debt, and a statement of assets. The processing and approval of your new mortgage may take up to a few months.
In conclusion, refinancing your mortgage can be a smart financial move if you have a proper plan. You may also want to read up on reverse mortgages as we have previously discussed here on Our Busy Little Bunch. Making sound decisions can save you a lot of headaches in the long run. To keep your head above water, don’t hesitate to ask for financial advice, and make those papers and numbers work for you.