Refinancing a home loan

Home loans can unlock additional value in your home. And just like mortgages, sometimes it can make sense to refinance them to benefit from lower interest rates.

Because a home equity loan acts like a mortgage, it’s also known as a second mortgage. It is different from a home equity line of credit, or HELOC, which is another form of borrowing against the value of your home. A home equity loan pays you a lump sum; With a HELOC you have a credit line up to a predefined maximum amount. With either type of borrowing, it is important to remember that your home is used as collateral, which means that if you default on repayments, the lender can seize it.

Most home equity loans have a fixed annual percentage; those with floating rates that can fluctuate with the economy are rare. You will make monthly payments, pay interest, and pay back the principal amount according to a repayment schedule during the term of the loan. And just like primary mortgages, home loan recipients can benefit from refinancing if the interest rates are lower than their current loan.

Pro tip

Lenders can, under certain conditions, be persuaded to reduce or waive the closing costs of a new mortgage.

“You want to refinance your home loan when you want to cut your monthly rate, lock in a lower rate, move from a floating rate to a fixed rate, shorten or extend the term of your current home equity loan, or borrow additional funds,” says Travis Tracy, Certified Financial Planner at Fortitude Financial Planning.

Consolidating higher-interest debt like credit card debt can be another reason to consider refinancing a home loan. A lower interest rate could put more money in your pocket every month. The additional funds you have at your disposal could be used to pay off those other high-yield debt. Just think of the risks of trading unsecured debt for secured debt like a home loan.

You can also apply for a new loan for an amount greater than the first to cover major expenses that may have been incurred since the original loan was taken out, such as: B. additional renovation projects.

Having a budget or starting out will help you determine the best target for the additional funds a refinance will provide you with.

“As long as you change your budgeting habits, this can be a great way to cut interest costs and find a clear path forward,” said Mark Struthers, Certified Financial Planner at Sona Wealth Advisors.

When refinancing a home loan doesn’t make sense

Just because you can refinance your home loan doesn’t mean you should.

“You may want to hold back refinancing your current home loan if your credit history has declined from when you took out the original loan, or if your total debt has increased,” says Tracy. He also suggests holding back if you’ve recently lost your job, as employment status is one of the most important factors a lender will consider.

Refinancing a home loan can also be difficult when the value of your home has declined, Tracy adds. The loan-to-value ratio (LTV) is an important metric that lenders consider when making or refinancing a home loan. the lower the better, all other factors are equal.

As with a regular mortgage, you should also consider closing costs, which several lenders claim is 2% to 5% of the loan. They can be incorporated into the total loan amount so you might not have to raise thousands of dollars to get it closed. A lender might also be willing to reduce or forego them so it is worth looking around. However, be aware that if you pay off the loan before a certain deadline, you may have to repay this as the lender will then lose your interest payments.

You can refinance with your current lender or find a new one; The former doesn’t necessarily give you the lowest price, so browsing around is recommended, says Tracy.

Either option requires you to provide the lender with detailed information about your property, income and employment status, the balance and monthly payments of your first mortgage, and any other outstanding debts.

The lender will then verify this information and your creditworthiness. Usually, you need a credit score of 620 or more to refinance, says Tracy. Note that values ​​below the commonly considered good credit threshold of 720 result in much higher interest rates than would be available for borrowers with better creditworthiness.

Bottom line

Refinancing your home loan can help your long-term financial strategy, but it’s important to know what it entails before you jump in. Setting a lower interest rate and lowering your monthly payments is very attractive, but seeking refinancing may not be a good idea if your creditworthiness has declined or your total debt has increased.

If you decide to move on, take the time to find the best price and inquire about the reduction or even waiver of the closing costs. With a little bit of preliminary work and care, you can get a solid business in the end.