|Refinancing a mortgage is a method where a lender pays your old mortgage for a new one. Let’s say you still have 15 years remaining on your 20-year mortgage plan, should you refinance to a shorter or start over with a 20-year mortgage to reduce your monthly payments?
Reasons to Refinance a Mortgage
Before you consider refinancing your mortgage, let us go through the reasons why you should do so.
1. Enjoy a lower interest rate
The main reason homeowners refinance is to obtain a lower interest rate, thus helping save money. Mortgage interest changes over time and refinancing allows you the opportunity to complete your home plan at a lower cost. This works together with shortening the mortgage term.
2. Obtain a shorter mortgage term
Shorter mortgage tenure will considerably reduce interest payments. This may result in a small or higher increase in monthly charge depending on your plan.
3. Convert mortgage plans
Converting from adjustable-rate mortgage (ARM) to fixed rate mortgage (FRM) or vice versa is achieved through refinancing.
Adjustable-rate mortgage is a mortgage plan with a varying interest rate throughout the loan period. ARM starts with a fixed interest rate at the start that changes periodically in years or months intervals. ARM is suitable for individuals who can pay-off within the specified time.
Fixed-rate mortgage is a type of home loan program that charges a steady interest rate throughout the mortgage term. FRM is a plan for easy budgeting and protects you from the sudden increase in monthly payments due to fluctuating interest rates.
Types of Refinancing
1. Rate and Term Refinancing
Rate and term mortgage plan is the most commonly acquired type of refinancing. Your initial loan is traded with a new mortgage program with lower interest rates.
Cash-out involves trading an old mortgage plan to a new program where you can get money from your home mortgage. A typical refinance plan will only reduce monthly payments. Cash-out programs can get around 125% of your home’s value.
Here is a type of plan permitting you to pay a percentage of your loan with a smaller payment plan.
Consolidation loans combine your debts to a single payment. This is a program for you if you are only paying your interest rather than your principal amount. The new mortgage plan comes with a structured payment scheme with due dates varying weekly, bi-weekly, etc.
Elements to Consider Before Refinancing
1. Home Equity
Factors that affect your home’s equity are the amount on the paid mortgage and the appreciation rate. To calculate how much you can borrow based on your home’s equity, calculate 80% of your house’s assessed value, and then deduct the amount of your mortgage. Note that your total debt service ratio (TDS) and gross debt service ratio (GDS) can affect the amount your lender is willing to provide.
2. Credit Rate and Debt Servicing Ratio
Your credit score and debt-servicing ratio play a big part in the approval for a new loan. Lenders measure your financial health using credit scores, giving them insights if you are a responsible creditor or not. Higher credit rating will get you the best possible interest rate. Improve your credit score by limiting credit charges below 30% of your credit limit. Another tip is to charge your bills and pay it on time.
Debt servicing ratio is divided into two, DTS and TDS
Total Debt Service Ratio (TDS) is the percent of your gross income perceived as consumed on household-related payments. Lenders look at your credit card balance, taxes and other monthly obligations to determine the amount and your payment capability. Creditors typically approve loans with 39% or less TDS ratio, while those with more than 44% TDS rate have a higher chance of being rejected.
Gross Debt Service Ratio (GDS) or housing-expense ratio compares your income and housing debt. GDS is based on your monthly or yearly housing expenses. GDS plays a significant role in determining the amount of principal offered to you.
3. Interest rate
The best time to refinance your mortgage is when mortgage rates fall. An article published by Bankrate says the mortgage rate plunged last December 2020 at less than 3%. According to Greg Mcbride, CFA of Bankrate, he foresees rates to reach 3.1% to 3.3% this 2021.
The rule of thumb in refinancing is when you can reduce your interest rate by 2%. However, some consider 1% saving is enough reason to refinance. Locking on a fixed interest rate before the price goes up is a way to take advantage of low-interest rates. So make sure to stay informed and grab the opportunity when loan charges drop.
4. Cost of refinancing
Before you commit to refinancing your mortgage, you must be educated with fees that come with a new loan. The typical refinancing cost ranges from 3-percent to 6-percent of the loan’s principal.
The cost hinges on variables like:
Other associated fees are:
Ask yourself if refinancing is worth the cost. Will you save more by doing so? How long are you planning to live in your home? The length tenure will increase your savings, as refinancing will get you a better interest rate from your initial mortgage plan.
5. Type of refinancing plan
Refinancing frees you from your old mortgage. It gives you the chance to select which type of mortgage plan suits your current situation and ultimately save you money. Choose the most cost-effective financial plan and capitalise on low mortgage rates.
Reminder: refinancing is optimal only if it reduces your debt, increases equity, and eliminates mortgage payments. Tapping on your equity is technically not advisable, as this leads to never-ending debt. Consider all the five things we have mentioned before deciding if it’s best for you to refinance your mortgage.
|If you need help with refinancing, we at Ripple Finance can help you get the most out of your loans. Let us do the legwork, and we’ll walk you through hundreds of options allowing you to make educated and informed decisions.|