Why do we need to refinance? What are the pros and cons? What is the cost of refinancing? How do we know whether it’s worth it to refinance or not? How to refinance without cost?
In this article, we will answer all these questions one by one below.
What is refinancing?
Refinancing means to get a new loan to pay off existing loans. After a lender receives the first loan, there might be changes in his or her financial situation, such as higher credit score and increased income. Other times, there might be changes in the interest rates and housing prices. All this means the borrowers can potentially get better terms on a new loan through refinancing.
What are the benefits of refinancing?
1. Reduce monthly mortgage payment
Mortgage rates have dropped to the lowest point in history since 2020, and many homeowners have seized the opportunity to refinance their mortgage and reduce their monthly payment.
For example, someone got a $500,000 mortgage a few years ago and the interest rate back then was 4.5%. The monthly payment of the principal plus interests was about $2,533. After refinancing, because the new interest rate was only 3%, the monthly payment was reduced to $2,108 (The actual cost was likely even lower, because the amount of the refinanced mortgage should be less than $500,000). After refinancing, the borrower can save more than $400 in mortgage payment every month.
2. Stop paying mortgage insurance
If you have less than 20% down payment when buying the house, it is required by law to purchase mortgage insurance.
When the housing market rises, however, the value of your house might become much higher than what you paid. That means your mortgage might now be less than 80% of the current value of your house. If you refinance, you would not need mortgage insurance anymore. (You can also ask the mortgage company to do a new appraisal of the house, so that you could stop paying the mortgage insurance.)
3. Change adjusted mortgage rate to a fixed rate
Mortgages with adjusted interest rates come with risks. After enjoying a lower interest rate for five or seven years, the rate will be adjusted according to the market of the time (as indicated by the LIBOR or SOFR index).
Therefore, many people that have adjusted-rate mortgages take the advantage of low interest rates to refinance their loans at a fixed rate. This way, they can avoid the risk of higher mortgage rates in the future.
4. Get the cash out
The general cash-out refinance allows you to borrow up to 75% to 80% of the house price.
For example, if the current value of your house is $1 million and the remaining balance of your mortgage is $500,000, you can use the cash-out refinance to get $250,000 to $300,000 in cash.
Many people get cash this way to be used as the down payment of their next house, or to pay off other debts with higher interest rates.
Will my current lender allow me to refinance?
Most conventional mortgages are sold by the lending banks or loan companies within 1-2 months of your house purchase. Therefore, the lenders usually won’t interfere if you want to refinance.
Some mortgages might have a prepayment penalty, but it’s very rare nowadays. If you are not sure, check with your mortgage service provider. (A mortgage service provider is a company that collects your mortgage payment every month. They don't own your mortgage, they are just responsible for mortgage services such as monthly payment collection, insurance, and property tax.)
How soon can I refinance after getting the first mortgage?
Conventional loans can be refinanced at any time.
However, some lenders require you to wait six months before refinancing the mortgage. Other lenders do not have such restrictions and are more than willing to help you refinance again.
In the following scenarios, however, you’ll need to wait some time before refinancing your mortgage:
1. FHA mortgage. If you don’t know what an FHA mortgage is, please read this article. If you own an FHA mortgage, you can refinance through the FHA streamline, which requires very few documents. The process doesn’t require a new appraisal, credit score, or proof of income. But you need to have a record showing that you’ve been paying the mortgage on time. There is a 210-day waiting period before you are allowed to refinance.
2. Cash-out refinance generally requires a six-month waiting period after the purchase of a house. Whether you bought a house with a mortgage or all cash, you have to wait for at least six months before you can withdraw cash through refinancing.
What’s the cost of refinancing and how to do it without cost?
Refinancing can be costly. So before taking out a new loan, you need to calculate whether refinancing is saving you money or not.
Although you have to pay some upfront expenses for refinancing, for every month after, you’ll pay less for your mortgage than before. Therefore, before refinancing, you need to calculate what the break-even point is.
The simplest calculation works like this: Assuming the refinancing saves you $400 a month and the cost of refinancing is $4,000, that means the break-even point for the refinancing is 10 months. You only start saving money at least 10 months after refinancing the mortgage.
There is also a way to refinance without generating any cost (no cost refiance). You’ll basically pay a higher interest rate in exchange for some cashback (credit), which can be used to cover the cost of refinancing. For example, if your mortgage rate is 3%, you’ll need to pay $4,000 for refinancing. If you choose a higher rate of 3.25%, however, you can refinance without any cost.
It’s generally recommended to refinance without cost, especially if you can still get a lower rate than what you’re paying now.
Mortgage interest rates have dropped since 2020. If you have not refinanced yet, there is still time left to take advantage of the low interest rates.
But always remember to compare rates when refinancing. Different mortgage companies and banks might offer different rates and charge different fees.
MRateQuote.com could help you find the lowest interest rates and best mortgage brokers that suit your financial situation and mortgage needs.