Back in 2020, due to conditions of the pandemic all markets and industries were suffering. People were losing jobs and their homes. It was an extremely challenging time for everyone. One way the government tried to make things easier was by reducing the interest rate on mortgages. At the time people had to be a lot more cautious about their choices but as 2021 has passed the halfway point, people feel safe enough to venture out again and take some risks. One of these decisions involves the question of refinancing their mortgage to take advantage of the lower Interest rates.
And for that reason, we are going to be looking to explore the basics of a mortgage refinance and the reasons to refinance.
Rushed decisions when interest rates drop
Interest rates dropping is one of the main reasons that people refinance their mortgage. By refinancing to lower rates, borrowers can reduce their monthly payments and by extension their total loan amounts. The money saved through these lower rates can be used to pay off other debts or into a person’s savings. Another goal that interests borrowers, when interests fall, is debt consolidation. If interests are low that means a borrower could refinance their mortgage to include other debts, for example, credit card debts. So not only would there be savings on mortgage payments but also credit card payments.
These ideas are sound and look good on paper but the reality is that whether they are a good idea or not requires analysis of the bigger picture and this picture will look different for different borrowers. It is best not to be impulsive about these ideas because a refinanced mortgage requires taking on a new loan and that means new costs, it only makes sense to go through with this if the savings are more than the costs of the refinance itself, otherwise the borrower does not break-even. Similarly, consolidating credit card payments into the mortgage will still require the card payments to be made on time and if there are any delays on that payment the borrower will now be risking their home instead of just a fine or penalty from the carcompany.
>>More: How to Refinance Your Mortgage?
What Is Mortgage Refinancing?
Let’s begin by going back to the basics of what a mortgage refinance is.
A mortgage refinance is the process of replacing your existing mortgage with a new mortgage, in this process you do not end up with two mortgages but instead, your new mortgage is used to pay off the remaining balance of your original mortgage. Additionally, the new mortgage comes with new terms, like lower interest rates for example. So essentially you have a new mortgage with better terms in place. However, since this is still one mortgage replacing another, the new mortgage will come with its costs. You will have to repeat most of the mortgage process to get the new mortgage.
Mortgage refinance requirements
You don’t necessarily have to go to the same lender as before if you want to refinance your mortgage. Since you will be taking out a new mortgage, it is best to begin by first shopping around and applying with multiple lenders to see who is making what offer. Once you have narrowed down which lender is offering the best deal, you can start the process with them. As mentioned, this will involve taking out a new mortgage so the requirements are mostly the same as last time, but there are some changes.
Mortgage payments: Since the lender will be offering you a new mortgage, you will be required to show documented proof that you are a reliable borrower that can make regular payments on your mortgage. For this, you have to show the last 12 months of payments you have made on your existing mortgage.
Equity: Just like the original mortgage required a 20% down payment for the property, to apply for a mortgage refinance, you must have at least 20% of equity or more. A borrower gains equity by making regular payments towards their mortgage, in a sense buying back the shares of the property from the lender who originally paid for it.
Income: This requirement is usually not an issue. If you qualified for the original mortgage then you obviously make a regular enough income that could afford the mortgage. However, the refinance amount might be higher than the original mortgage so lenders do want to make sure you can still afford the payments. But since income usually increases over time and most people apply for a refinance once a significant time has passed, income is not usually an issue.
Credit Score: The credit score requirement is also not much different from the original mortgage, so if you have been making regular payments on your debts since taking out the first mortgage, you should have no problems here. But it is best to request credit reports before going to the lender just to be safe.
When to Refinance Your Mortgage
There are many reasons to consider for refinancing a mortgage, it is always best to evaluate your financial position to ascertain if a refinance works for you or not. Following are some reasons why people will choose to refinance their mortgage.
1. You Have an Adjustable-Rate Mortgage (ARM)
If you have an adjustable-rate mortgage, this means that the interest rate is fixed but only for a certain period, once this period is over, this rate will change to something else, usually a much higher number. An ARM can be very useful because during the period of the fixed mortgage the interest rate tends to be very low. But since the rate will change to a higher number later, borrowers prefer to refinance their mortgage to a fixed mortgage, especially when the market interest rate is lower.
2. The Length of Your Mortgage Is Over 15 Years
The benefit of a long-term mortgage, like a fixed-rate mortgage of 30 years, is that they have lower monthly payments than short-term mortgages. However, a 30-year commitment even for a mortgage is a very long time to remain in debt. For this reason, many borrowers prefer to refinance to a 15-year short-term mortgage when they are able to. By refinancing into a short-term mortgage, they do end up paying more on a monthly basis but reduce their total loan amount and might even get a lower interest rate in the process.
3. You Have a High Interest Rate Loan
The most straightforward reason why a borrower will refinance their mortgage is to get a new mortgage with a lower interest rate. A higher interest rate means paying more on a monthly basis and also having a higher total amount, a reduced interest rate can mean a lot of savings in the long term. But it is again, important to consider whether these savings will be considerable enough compared to the costs of refinancing itself. Taking on the costs of a refinanced mortgage makes the most sense if you are planning to stay in the property long-term. It is not advisable to refinance even for a better interest rate if you are planning to leave the property or sell it in a few years. Because then you’ll be paying huge costs but not breaking even.