Why and How TO Refinance Your Mortgage (A Beginner’s guide)

Refinancing isn’t for everyone, no matter what the friendly loan consultant on the other end of the phone may say.

They are there to help you yes but within their own scope of interest.

The truth is it’s important to know the facts when it comes to refinancing because yes, it can be a great option for you, but what exactly is the catch?

Is it ever truly wise to refinance your mortgage?

We’re here to explain it all to you.

What Exactly Does It Mean To Refinance A Mortgage?

When you refinance, it means, the lender will take the balance of your mortgage (what you have yet to pay on your loan) and recalculate that amount over a new term.

So, for example, if you’ve paid off half of your mortgage already and you decide to refinance you will be turning the remaining balance into a new loan over a new term, but without going through the entire process again.  

The old loan is then replaced by the new loan.

When Is It Wise To Refinance?

Whether or not that is the best option for you, can only be determined by you. But as for the best conditions to refinance, we can tell you what the experts say:

When You’re Credit Score Had Improved

Perhaps when you first applied for your mortgage loan your credit score was not so great (for whatever reason.)

Your credit score can not only influence what type of mortgage lenders will give you, it will also influence what your interest rate will be.

The lower your credit score, the more of a risk you are to the lender.

This (ironically) means that your calculated rate will be higher than someone with a good or average credit score in order for the lender to get their money’s worth when taking a chance on you.

The bright side, however, is that if your credit score has improved substantially, it means you that you don’t have to stay stuck on the interest rates calculated for you back then.

Interest Rates Have Gone Down

You could find the house of your dreams when the economy is low and interest rates are high, it’s unfortunate but it happens.

So you can either take a mortgage with an obscene interest rate or lose the home of your dreams. Most people are going to choose the latter because it does actually make sense.

So when the interest rate improves you could try to refinance, if you’re successful, you could be saving some extra money for a vacation, or a new car or anything really.

There is a gamble though, but the worst that could happen is that your refinance loan is turned down and you still pay the same amount that you used to.

You Want To Pay Off Your Mortgage Faster

Although it is mainly used to lower monthly payments, it can also do the opposite.

You can refinance to a shorter term if you want to pay off your mortgage faster. In turn, you will have a higher monthly payment.

There is some debate about whether you should simply make extra payments instead of refinancing your mortgage entirely.

After all, once the loan is recalculated to a shorter term, you could also have a higher monthly repayment simply because of a new interest rate.

That means there are two things that can cause your monthly payments to be higher.

Something to think about if you want to refinance for this reason.

You Want to Lower Your Monthly Payments

The thing with homes is that humans tend to live in them, and the thing with humans is that anything can happen in our lives and specifically, in our financial situation.

You could have had a couple of extra kids, or you could otherwise be unable to guarantee an income high enough to afford your current mortgage repayment.

Refinancing your mortgage can allow you to save a substantial amount of money.

Although it can extend your term of repayment up to 10 years, most people are willing to accept the increased term if it means they can have a better quality of life for that time.

To Convert An Adjustable Rate Mortgage To A Fixed Rate Mortgage

Adjustable Rate Mortgages (ARM) is when your loan’s interest rate is not fixed and fluctuates based on numerous circumstances such as the economy, market trends etc.

There are Adjustable Rate Mortgages that have a small portion of the term that is fixed, either the 5 (5/1) or 7 (7/1) first years (or whatever the case may be) this is referred to as a hybrid ARM.

In layman’s terms, a hybrid ARM means the indicated amount of years will have a fixed interest rate and thereafter your interest rate and the amount you pay will fluctuate.

The majority of people will not purposefully apply for an ARM, but sometimes it can be the only way for someone to get a mortgage.

Refinancing can mean that you will no longer run the risk of fluctuating interest rates.

What Do You Need to Qualify For Mortgage Refinancing

Your credit score and general financial health will determine whether or not you can refinance your mortgage.

However, most lenders will also require you to have 20% equity (the difference between your home’s fair market value and the amount still owed on your mortgage) in the house.

To determine whether or not you have the required percentage of interest you can do the following calculation:

  1. Amount to be refinanced ÷ market value of your home = LTV percentage (loan-to-value)
  2. 100% – LTV %= Equity percentage.

For example,

$50 000 ÷ $80 000 = 0.625 (62.5%)

100% – 62.5% = 37.5% equity.

How to Apply:

If you want to refinance for one of the reasons above or your own, you can go see your lender with your paystubs, tax returns, credit report, statement of debts and statement of assets.