Refinancing your mortgage can be a smart financial decision when done with some research and knowledge of what the process entails. Often the initial costs of obtaining the new loan are recouped within a few years, and the savings on interest are well worth it.

What Does it Mean to Refinance?

Refinancing a mortgage means paying off an existing loan and replacing it with a new one. Things may have changed since you obtained your original mortgage, and refinancing allows you to take your home loan into a better place for you now. The new loan should be an improvement on the old loan, whether it’s better terms, lower payments, or a shorter loan length. In some cases, a refinanced mortgage may allow you to cash out a percentage of the equity you’ve already accrued.

What are the Reasons to Refinance?

There are several reasons to refinance. One of the best reasons to refinance is to lower the interest rate on your current mortgage. In the past, refinancing was only recommended if the interest rate would be reduced by 2% or more, but now lenders are saying that even a 1% interest rate reduction can provide enough incentive to refinance. Borrowers who initially financed their home with an adjustable-rate mortgage (ARM) often find that refinancing to a fixed-rate mortgage can save them from higher payments. Some borrowers refinance to shorten their loan term, to consolidate debt, or to tap into their home equity to finance a remodel or a large purchase.

What Goes into Qualifying for a Refinance?

Qualifying for a refinance is often similar to qualifying for the first mortgage. You need to prove to the lender that you have income to cover the loan, as well as any other debt. In most cases, you will provide pay stubs, bank statements, and past tax returns. You’ll need to make sure that you are in good financial shape and that your credit report is clean. You need your score to be as high as possible to get the most favorable rates. Most of the time you will need at least 20% equity in your home.

Is Refinancing Worth It?

Refinancing isn’t without its own cost. Borrowers can prepare to pay between 3% and 6% of the principal. The refinanced loan will also require an appraisal, a title search, and other fees. Yet the long-term gains of refinancing can help you build equity more quickly, pay less in interest, and, in the case of ARMs, reduce the risk of interest rates rising.

When refinancing to consolidate debt or to tap equity, refinancing can be a slippery slope. Mortgage interest is tax deductible, and the interest rate on a mortgage is almost always less than financing a major purchase or remodel through other means. However, adding home debt, especially at a 3-6% initial cost, is something that should be carefully considered with a mortgage broker or financial advisor. It’s also important to note that you can only take up to a certain percentage of your equity as a cash out.

Finally, refinancing is only a smart move if you plan to stay in your current home for at least a few years and can justify the initial expense with interest savings over time. Talking to a mortgage professional about refinance options is the best way to begin. Contact us today for more information!