Purchasing a home is a major life event and a large investment. Refinancing your home provides you the opportunity to leverage your investment, whether you need cash, want to lower your payment, or want overall better terms for your mortgage. Refinancing is getting a new mortgage to replace your home loan. When you refinance with your local credit union, you also take advantage of the closer relationship, better customer service, and lower interest rates that typically accompany banking with a credit union instead of a big bank.
Before you refinance you need to have a better understanding of the process, your loan options, and the advantages and risks associated with financing. This guide offers in-depth information about refinancing your home with a local credit union, so you can make informed decisions when you are ready to take action.
How Does Refinancing Your Home Mortgage Work?
When you purchased your home, you went through the mortgage application process to qualify for a mortgage. Your lender approved you and funded your home loan; they paid the seller of your home and you make payments to the bank for the loan. A mortgage refinance requires going through a similar process. Refinancing means you qualify for a new mortgage, usually with different terms, and pay off your existing mortgage. You are then left with one mortgage and a new payment. Refinancing your home also requires you to qualify and meet lender requirements and go through the same underwriting process and closing that you went through with your initial mortgage.
Why Do People Refinance Their Mortgage?
Homeowners choose to refinance their home loans for several reasons. They include:
Decreasing Monthly Payment
Refinancing your mortgage for a lower interest rate and/or to extend the term of your mortgage reduces your monthly payments.
Avoid a Balloon Payment
Homeowners sometimes choose a balloon program to keep their monthly payments low. This means their mortgage has regular payments each month, but borrowers must pay a large balance at the end of their term, typically five or seven years. Homeowners who want to avoid paying a large balloon payment choose to refinance to a new fixed-rate or adjustable-rate mortgage (ARM).
Get Some Cash
Some homeowners need cash for a big purchase or project, so they refinance and borrow more than they owe on their current mortgage. Their lender gives them the difference.
Pay Off Their Mortgage Faster
Many homeowners shorten the length of their mortgage to save money on interest. Refinancing your 30-year home loan into a 15-year home loan allows you to pay off your mortgage in half the time, saving you thousands in interest over the life of your loan.
Switching Loan Types
Sometimes borrowers run into a situation where the rate on their Adjustable Rate Mortgage (ARM) increases too much, resulting in an increase in monthly payments too. One way to fix this issue is to refinance an arm into a fixed-rate loan with predictable monthly payments that provide more financial stability for a household.
Drop FHA Mortgage Insurance
Once you have enough equity in your home, you can cancel private mortgage insurance (PMI) required by your lender. If, however, your initial mortgage was funded by the Federal Housing Administration (FHA), you are currently paying a mortgage insurance premium (MIP). Typically, homeowners must sell or refinance to discontinue their FHA mortgage insurance.
What Costs Are Associated with Refinancing?
When you purchased your home, you had to pay closing costs unless you negotiated for the seller to pay them. Home loan refinancing also requires you to close and pay associated costs. One of the benefits of refinancing your home loan with a local credit union is that credit unions often do not have as many closing costs as traditional banks or fees are lower. Typical closing costs for a refinance loan include:
- Application fee to cover the cost of the processing the loan application and pulling your credit report
- Fees for Title Search and Insurance to cover any potential problems or inaccuracies in the property’s title and to verify property ownership
- Attorney fees for the lender’s legal team who conducts the closing
- Loan origination fees for the lender’s work preparing a mortgage
- Points, which are prepaid financial fees the lender charges at closing
How Do I Qualify to Refinance My Home?
You must prove your creditworthiness to qualify for a home mortgage; the same is true when you refinance your home. Most mortgage refinancing options require borrowers to have a dependable income, good credit, and at least 20 percent equity in their homes. You can use a mortgage calculator to run some numbers and see how new payments and interest rates fit into your budget. Requirements vary among lenders and also among different types of refinance loans. Some specific things you can evaluate to ensure you qualify to refinance include:
Refinancing might not make sense if you don’t have enough equity in your home. Generally speaking, you need at least 5 percent equity to refinance, but the more equity you have the better. You should know approximately how much equity you have in your home before you apply to refinance.
If you’re DTI has increased significantly since you qualified for your initial mortgage, it could hurt your chances for refinancing. Lenders want to make sure you can afford your new mortgage payment. Broad guidelines include making sure your new payments are not more than 30 percent of your monthly gross income and your total debt should be less than 40 percent when refinancing.
Refinancing replaces your first mortgage with a new mortgage. While it’s not a total deal-breaker, refinancing with a second mortgage poses additional challenges to the process. When you refinance, your lender must take risk because your second mortgage gets paid first. Refinancing with a second mortgage usually means consolidating the two mortgages into one loan.
Additionally, if you have any liens on your property from unpaid taxes or other obligations, you need to resolve them before you attempt to refinance your home. Involuntarily leans typically prevent homeowners from refinancing.
Upside Down/Under Water
If you are upside down, also called ‘underwater,’ on your mortgage, it’s difficult, if not impossible to refinance. When you are upside down, it means you owe more on your mortgage than the value of your home. Changes in the housing market can cause this to happen. Homeowners typically need to wait it out, keep making payments, and build more equity until they have enough equity to justify refinancing.
Types of Refinance Loans
Credit unions and other refinance lenders offer a selection of different types of refinance loans. The type that is best for you depends on the purpose for refinancing your home and how much equity you have. Common types of refinance loans include:
The vast majority of refinancing loans are rate-and-term refinances, especially when mortgage rates are falling. Homeowners refinance to take advantage of lower interest rates, shorten the length of their loan, or change their loan structure from an ARM to a fixed-rate mortgage. Sometimes homeowners do both. In most cases, this type of refinancing results in lower monthly payments for homeowners, and they save money on interest. Yet, when homeowners shorten the term of their loan, their payments often go up. Lenders typically do not offer cash back at closing for rate-and-term refinancing, but they do often allow homeowners to add closing costs to the balance of the loan, so they do not have to pay out-of-pocket to refinance.
This type of refinancing occurs when you apply for a new loan and pay off your existing debt with the new loan. If you have a second mortgage, a home equity loan, and or a home equity line of credit (HELOC), a consolidation loan provides the opportunity for one loan that can have a lower rate than the average interest you are paying across multiple loans and lines of credit. In some cases, a consolidation loan also results in a lower monthly payment than all the payments for combined debts.
A cash-out refinance involves leveraging the equity in your home to walk away from the closing with a lump sum of money that you can use for whatever you need or want. The terms of your mortgage might change in cash-out refinancing. For example, you might have a 15-year loan instead of a 30-year loan and you might have a lower mortgage rate than your original loan; however, the primary difference between a cash-out refinance and other types of refinances is that you will owe more after refinancing.
Lenders typically require that you have at least 20 percent equity in your home for cash-out refinancing. Additionally, credit requirements can be higher as well as other requirements for approval. In a cash-out refinance, your lender gives you a loan that covers the amount of your current mortgage and gives you cash for an additional amount based on the equity you have in your home.
Homebuyers can use cash-out refinancing to consolidate debt, but typically this type of financing involves using the cash for a big event like a wedding or anniversary, paying for college, or making home improvements. As an added bonus, the IRS allows you to deduct the interest you pay on a cash-out refinance when you use the funds for home remodeling or renovations.
The opposite of cash-out refinancing is cash-refinancing. With this option, you bring cash to the closing to pay down your mortgage. Some homeowners choose cash-in refinancing to access lower interest rates on their mortgage. Typically, lower loan-to-value ratios lead to lower interest rates for borrowers. This is also the type of refinance you might use to get out of MIP payments required by the FHA.
Risks of Mortgage Refinancing
Refinancing your home with a local credit union offers many benefits to homeowners, but it also comes with risks. You need to weigh your financial situation and loan options carefully to ensure you are making the best choice. In most cases, refinancing is a great option if your new loan has a lower interest rate than your current mortgage. Even if you keep the same length of a mortgage, you save money by the interest reduction.
Cash-in refinances simply to benefit from lower interest rates might not always be worthwhile. Sometimes you incur penalties for paying down your mortgage with a home equity line of credit. Many mortgage agreements have clauses allowing the lender to charge fees. If your interest rate savings do not cover the penalties, you might be better to wait for refinancing.
Additionally, if you have to sell your home in the near future because of job loss or relocation, you might end up spending money on closing costs for a new loan that won’t benefit you in the long run. Although you have no control over some big life changes, refinancing your home means you should be prepared to stay there for several years.
Finally, not all homes go up in value, or they might lose value while you are making payments. When you refinance, you need an appraisal for your lender to make the right offers for you. If your home has lost value or not increased in value, the appraisal will directly impact the terms and interest rates lenders offer you for refinancing. This can especially influence the amount of money you receive in a cash-out refinance and put you in danger of going upside down on your new loan. Ultimately, you need to consult with a mortgage lender at your local credit union to learn about the best refinancing options for you.
Looking to Refinance Your Mortgage? Contact Dane County Credit Union Today
Are you looking to refinance your home mortgage for cash or to get better terms on a new loan? Dane County Credit Union has proudly served residents and employees in Dane County and the Greater Madison Area since 1935. Contact us today about your refinancing needs. Our mortgage team can help you better understand your refinancing options, start your application, and guide you through the refinancing process.