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What is a Refinance?
The term Refinance refers to the process of getting a new loan to pay off the current loan. When you refinance your current mortgage. your current mortgage will be paid off by the new mortgage. The main reasons for refinancing are to have better interest rate or to have better loan terms than the current one. The refinance process looks very similar to the home mortgage process, but with no purchase agreement or inspection. This process works by taking a new loan on the same property to provide financial benefits.
Process of Refinancing
The first step in the process of Refinancing is to analyze the options and benefits that best suits your financial situation. The interest rate and terms of the loan are also decided by the credit history, so you may get an idea of what mortgage rates you might qualify by pulling your credit report. If you find that your credit is dropped, you may improve your credit score before refinancing. If there are any errors in the credit report, you may dispute the information with the credit reporting agencies.
Then a mortgage loan application is submitted. You may also be able to get loan estimate without formal application submission depending on the mortgage providers. Once the application is submitted, the lender will start the process of Underwriting. The process of Underwriting involves the verification of the information submitted on the application and Process for Appraisal of your home. The Appraiser estimates the value of your home. If the value of your home is less than the current loan value, you may either cancel the application or do a cash in refinance by bringing in cash to close to be eligible to qualify for your new loan terms.
Refinancing costs
When refinancing the mortgage, there are certain common fees that may be applied. There are several Mortgage Options available for refinancing such as Cash in refinance, Cash out refinance, No cost refinance etc.
Recording Fee - This is a fee charged to handle the paperwork
Loan Origination Fee - Compensation for process of Loan Origination.
Document Preparation Fee - This fee is for the preparation of documents.
Mortgage Application Fee - Fee for the mortgage application.
Appraisal fee - Cost of the appraisal process of the home.
Mortgage Points - Charged to reduce interest rate or have better loan terms.
Flood certification Fee - In areas where the flood certification is necessary.
Title search fee - Fee paid to the title company to search title history and to make sure the property is free and clear of any liens.
Inspection Fee - Fee charged to evaluate the working condition of the property.
Survey Fee - Fee collected to ensure the boundaries of the property to prevent encroachment.
Credit report Fee - The lender may charge a fee to determine the creditworthiness of the refinancer to the terms of new loan.
Factors determining the closing costs
These are some of the factors by which the cost of refinance is determined.
Location - Appraisal costs and other costs involved in the process vary depending on the location.
Size of the Loan - Depending on the size of the loan, the closing costs vary.
Type of Refinance - Generally, cash out refinance has loan terms of higher interest rate and may also be charged private mortgage insurance if the equity reduces less than 20%.
Discount Points - These are the points paid to get a lower interest rate on the loan terms.
Other Fees - Other fees that may be included in the closing costs are appraisal fee, title fee, application fee etc which vary depending on the location, lender etc.
Is No cost Refinance loan possible?
No cost refinance means there is no upfront payment of closing cost during refinance. Instead of paying the closing cost upfront, the lender rolls the cost into their loan.
The lender may also provide a lender credit which works in reversal to the points where the lender takes care of the closing costs, instead charges the refinancer a higher interest rate on their loan.
Pros of Refinancing
Lower Interest rate
Having a lower interest rate is the most common reason for refinancing. Lower interest rate reduces interest paid for the entire term of the loan. In a long shot, several thousands of dollars may be saved due to this. To obtain lower interest rate it is important to have and maintain a good credit score.
Pay off Loan faster
By the process of refinancing, you may change your 30 year loan term to 15 years which in turn reduces the interest rate paid over the life of the loan and makes the ownership of the property without having to deal with monthly mortgage payments faster.
Stabilize your Interest rate
By switching the loan from ARM to fixed rate, it not only stabilizes the interest rate but also helps to achieve a more predictable monthly payment. As there are not any unpredictable fluctuations on the interest rate of the loan, it may help in better planning of your monthly expenses.
Cash out refinance
Cash out refinance helps in cashing out money from your equity which may be used for home renovation projects, college fund or to invest in any other endeavors.
Eliminate Private Mortgage Insurance
If the down payment is less than 20% in a conventional loan, the lender may charge you private mortgage insurance (PMI) to better protect their finances. As the time passes and your equity grows equal to 20% or more, then the private mortgage insurance may be removed by refinancing. It can also be removed by just calling the lender and some lenders do it automatically when the equity reaches 20%.
Converting Jumbo loan to conventional
Jumbo loans usually have higher interest rates as they exceed the usual loan limit set for conventional loans. Once the value or loan amount drops within the conventional loan limit, it may be refinanced to have lower interest rate.
Cons of refinancing
Restart of the mortgage term
The mortgage term restarts each time you refinance, for example, you have a 30 year loan and it has passed 10 years already and if you decide to lower your interest rate by refinancing, then the mortgage clock resets. The remaining period on the loan extends from 20 years to 30 years. You can take a 20 years or 15 years fixed mortgage instead to avoid this disadvantage.
Recuperation period
The process of Refinancing involves certain closing cost and it may take a while for the recuperation of the closing cost paid in the lowered monthly interest payment. If you are planning to live in the house for short term or planning to sell the home in few years, refinancing may not be worth it. Most refinance is done with zero closing cost, where the refinance cost is part of the interest rate.
May not get approval
While applying for the refinance, the lender may take a look at lot of factors such as credit score, credit history, debt to income ratio, employment history etc. If the credit score has lowered or if there is an increase in debt to income ratio or have lost job recently, you may not be approved for refinancing as the lender feels it to be a risk to lend money to the refinancer.
Application process
The process of refinance has a lot of factors considered and requires a lot of paperwork to be submitted and go through an underwriting process. If there is not much of a change in your interest rate or benefits obtained on the terms of the loan, it might be a hassle to go through the process.
Backfire in a down market
If your home is in areas of declining housing market or an area where there are frequent short sales or foreclosures, the lender consider it a high risk area and you may not be approved for refinancing. It is advisable to wait on refinancing until the market condition improves.
Refinancing when used carefully, may be very valuable to bring your debt under control. Each situation is unique and the decisions made after careful analysis may benefit your financial condition overtime.
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