Refinancing a home sounds like a complicated grown up thing, doesn’t it?
But the reality is that if you’ve bought a home with a mortgage, you’re more than capable of refinancing. (You won’t even need to call your mom or dad to help lead you through it.)
But first, what is refinancing a mortgage? Basically, refinancing is paying off your current home loan with a new mortgage loan. (Ideally one that comes with better terms to help you achieve your financial goals.)
Of course, you can do a mortgage refinance for a variety of purposes. But what we’re going to focus on here is getting you out of debt sooner rather than later.
Refinancing strategy #1: Qualify for a lower mortgage rate, but make the same monthly payments.
Have you made your monthly house payments on time? Is your credit score better than it was when you first bought your house? Or did you buy your home when rates were higher than they are now? If your answer to any of these questions is yes, you’ll likely qualify for a better rate.
The life hack portion of this is that once your monthly payments go down, you can continue to make the same payments you did with your original mortgage rate. Just be sure to direct the extra funds towards principal. Doing so reduces the amount of payments you would have to make over the life of the loan. Meaning, you would be out of debt sooner.
Strategy #2: Refinance to remove private mortgage insurance (PMI) payments.
If you used an FHA loan to buy your house and put 3.5% down, you’re likely making monthly PMI payments.
PMI stands for private mortgage insurance, and it’s there to protect the lender. It can range from 0.5% to 1% of the loan amount charged annually, and is part of your monthly payment. So say you have a loan amount of 200,000. In that case your PMI payments could be as high as $166.66 a month.
Contrary to what many people believe, FHA loans do not currently drop PMI payments once you have paid the loan to value of your mortgage to 78% or less. (Meaning you have 22% or more equity in your house.) PMI stays for the life of the loan unless you do something about it.
You used to be able to drop PMI payments on FHA loans, but you had to buy your house between December 31st, 2000 and July 3rd, 2013 and put more than 10% down at closing to qualify. If you bought your house either before or after or didn’t put more than 10% down, your monthly PMI payments aren’t going anywhere— no matter how much equity you have in your home.
Luckily, you can refinance to a conventional loan. Do this once your LTV (loan-to-value) reaches 80% or less, and you won’t have to make PMI payments any longer.
Why refinancing a home loan to remove PMI can help
The idea is to take your previous PMI payment and throw it back on top of your monthly mortgage payments. The ‘extra’ money can be used to cut away at your principal each month. So while you’ll be paying the same amount each month as before, your house will get paid off faster.
How do you know if you have enough equity to remove PMI?
If you’ve been working to pay off your mortgage early, you may have already reduced your loan balance enough.
But regardless of how much you’ve paid toward your loan balance, you may have already reached 20% in equity. This is because your home may have risen in value since you bought it.
To quickly gauge whether you have enough equity or not, what did your last tax assessment say your house was worth? It won’t qualify as an official appraisal, but will give you an idea. Once you have that number, take how much you have left to pay off your loan, then divide it by the tax assessment value. Finally, multiply the result by 100 to get the loan to value percentage.
Here’s an example:
$190,000 loan ÷ $240,000 tax assessment = 0.79
0.79 X 100 = 79% Loan to Value
Strategy #3: Refinance to shorten your loan term.
If you bought when interest rates were high and your credit score was low, it’s possible you could cut your interest in half if your score has since improved. By doing this, if you were to stick with the same monthly payments, you could conceivably shave your loan term in half by going from a 30 year fixed-rate mortgage to a 15 year-fixed rate mortgage.
It’s not out of the question. In 2008, many people received interest rates of 8% or higher. Currently, rates are around 4%. It’s been 11 years since then, but if you were to refinance now, you could shave off four years of mortgage payments. That’s a lot of money you would save!
Keep in mind that the Fed recently announced that it has no intention of raising rates in 2019. So this could be a good year for you to refinance.
Strategy #4: Refinance to pay off your monthly debts.
Refinancing is also a strategy some people use to pay off debt, which, overall, could help you pay off your mortgage.
When my wife and I bought our first house, we were living on only my teacher’s salary. It was my first year teaching, and we were about to have our first child. We wanted to get out of the city and get closer to where I was working. We couldn’t afford much, but wanted to make a sound financial decision.
So we bought a foreclosure. It assessed very well, but needed thousands of dollars of work. Luckily, we got it for a fraction of what it was listed at, but it took us four years to update and remodel it. It was the classic sweat equity scenario.
When we refinanced, we did a cash out refinance. In our case, we cashed out on a portion of our equity and used that money to pay off our student loan debts. Though our monthly mortgage payment went up a little bit, when we factored in all of our monthly debt, we saved $400 a month by refinancing. Though we sold shortly afterward, we could have put that $400 towards the principal each month to shorten our loan term.
(Jackie’s note: While this worked great for Patrick, beware of the danger of trading unsecured debts like credit card debt for debt that is secured by the house you live in. It can backfire if you end up unable to pay for long periods, because the lender can take your house.)
Is refinancing a mortgage for you?
To see if refinancing might help you, call up a lender and do the math.
You do have to pay closing costs when you refinance, just as you would with a new mortgage, so make sure you consider those costs when weighing how much money you would save.
When all is said and done, would you save more overall each month? If so, then it may be time to refinance.
How to refinance your mortgage
Here’s a quick breakdown of how to refinance your mortgage.
1. Estimate your home’s value:
Go to Realtor.com or Zillow and look up recently sold homes near you that are comparable to your house. This isn’t exact science, but you want to get an idea for how your home will appraise. (Note: You can also use your home’s most recent tax assessment as a starting point.) Find the house that is most like yours in your area and use that to get an idea of your home’s current value. Usually lenders like to see 20% equity, but this isn’t a must. If your credit score has gone up a lot, lenders may allow you to refinance.
2. Find out your credit score:
Everyone has three credit scores— one from TransUnion, Equifax, and Experian. All of them should be relatively close to one another, so it’s not necessary to worry about learning what each is. You just need an idea here of how good your credit is. However, know that your lender will use the middle score as your credit score, and they will pull your scores themselves.
3. Compare mortgage loan offers:
Shop different lenders to find the best refinance deal for your scenario. Do this within a short time period (say, 14 days or less) to help reduce the impact on your credit. There are multiple ways to structure a refinance deal, which often depends on your overall goals. Also compare costs: upfront, monthly, and overall. Refinances do come with closing costs, which either need to be paid upfront or rolled into the new mortgage. Each one has a different impact on your finances.
4. Go through the loan process:
You’ll basically be asked for all of the same paperwork as you were for your first mortgage. This means taxes, pay stubs, assets, etc. If you don’t have a scanner, smart phones work just as well these days. The lender will also schedule an appraisal to confirm the value of your home. You typically must pay this fee out of pocket before the appraiser arrives.
Pay whatever fees you need to pay, and enjoy your newly refinanced mortgage. If you’re using the refinance to pay off your mortgage faster, make sure you specify that any amounts above the regular monthly payment go to principal.
About the author
Patrick Ward blogs at www.hipsterrealestate.net to help demystify debt, mortgages, and down payment assistance programs for first time homebuyers and current homeowners. He has a BA from the University of Virginia. Patrick currently lives in the New River Valley of Virginia with his beautiful wife and three wonderful children.