What Is a Refinance Loan?
When you refinance your mortgage, you’re basically trading in your old loan for a new one with different terms and payments. By taking out a new loan, you’ll free up equity that can be used to update the home, pay off high-interest credit card debt, and more. Many older Americans are also refinancing as a way of securing lower interest rates, which helps reduce overall monthly expenses. Both options can help you greatly improve your finances during retirement, when your income sources might be limited.
Who Should Refinance?
Refinance loans are great for those who want to tap into home equity or lower their monthly mortgage payments but may not qualify for a reverse mortgage loan.
How a Refinance Loan Works
When you refinance, you are replacing your old mortgage loan with a new one to withdraw some of your equity in cash or to secure a rate and/or term that is more favorable. When done right, refinancing can be a smart move that can save you thousands of dollars and greatly improve your financial picture in retirement.
What to Know About Refinancing
If you’re looking to refinance, you’ll want to assess your financial goals, property value and the benefits of trading in your mortgage before determining the best path forward. Here are some important factors to consider:
Review your financial picture.
Before launching into the refinancing process, it’s important to take a moment to review your financial status. What does your monthly budget look like? How much of your income is spent paying off debt? What does your credit score look like? Taking scope of your situation can help you better understand if refinancing would be a smart move.
Also, consider your property value. Look at comps in your area. Has the value of your house gone up? How long do you plan on staying in the home? If you want to remodel, will the changes improve the value of your home? All of these questions are important to consider before you pursue a refinance loan.
Calculate your break-even point.
Just like taking out any other mortgage, refinancing comes with closing costs, which are typically about 2-3% of the loan amount. You’ll want to make sure that the expense of refinancing is outweighed by the savings you’ll incur with a new loan.
To determine if the benefits exceed the cost, calculate your break-even point, or the total closing costs divided by your monthly savings. For example, if your refinance will cost $2,000 and you’ll save $100 per month, it will take you 20 months to recoup the expense. If you plan to stay in your home for several years, the savings may be worth the expense.
Secure a lower rate if you can.
When getting a refinance loan, a general rule of thumb is that you’ll want to reduce your interest rate and plan to be in the home for a while. Talk to an AAG home equity professional about the rates that may be available to you.
What Type of Refinance Loan Is Right for Me?
Refinancing can be a smart way to reduce your monthly obligations, lower your overall loan balance or eliminate high-interest debt. Selecting which option is right for you depends largely on your financial picture. An AAG home equity solutions professional can walk you through your options.
Rate and Term
Trade in your old mortgage for a loan with a new term and interest rate, altering the duration of the loan and the amount you’ll have to pay every month.
- Take advantage of lower interest rates to reduce your monthly payments.
- Shorten the term of your loan to save money and pay off your mortgage faster.
- Lengthen the term of your loan to reduce your monthly bill.
Take out a new loan for an amount that exceeds what you owe on your house and get the difference in cash.
- Turn your equity into tax-free* cash.
- Fund home modifications, finance a large purchase or pay off high-interest debt.
- Possibly deduct the mortgage interest from your taxes.
Yes, an appraisal is a required part of the process. AAG will send an appraiser to your house to assess the property and make a judgment on its current market value. This will be used in determining the final loan amount.
By selecting a cash-out refinance, you can access funds to pay off high-interest debt. This can be a smart move because the interest rate on your mortgage is likely to be lower than the interest you’re paying on credit cards or other types of debt, and the interest you pay on your mortgage may be tax deductible. This is one area where you may want to consult your tax advisor.
If you’re thinking about refinancing, you’ll need to have built up enough equity in your home, which means you’ve been there for at least a year, and you’ll need to be current on your mortgage payments. If interest rates have dropped, or if your adjustable-rate mortgage is about to adjust, it may be a good time to refinance your loan.
If you’re looking to refinance but are concerned about your credit, there are options out there to help. A conventional refinance requires a minimum credit score of 620, but of course, the higher your score, the better your rate.
While refinancing with bad credit will likely mean you’ll be offered a higher interest rate, it might still be a smart move if you can still lock in a rate that is lower than your current mortgage.
If your credit score is lacking and you’re worried about your options, consider the HARP 2.0 or, if you have an FHA loan, an FHA Streamline. Both options are designed to help homeowners with less-than-stellar credit reduce their mortgage payments.
A refinance loan typically costs about 2-3% of the loan amount. Ensure that your savings will outweigh the expense by calculating your break-even point, or the total closing costs divided by your monthly savings.
Yes, it is possible to refinance your conventional mortgage into an FHA loan, and the rates are comparable to conventional loans. Refinancing into an FHA loan might be a solid option if you have spotty credit, as these loans have less stringent credit requirements. But the trade-off is that FHA loans come with upfront and recurring mortgage insurance premiums. Talk to your AAG professional about whether refinancing into an FHA loan makes sense for you.
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