Key Things to Know About Refinancing a Home Loan

Through their many loan products, lenders allow homeowners to refinance their home loans and secure better terms. Through this process, homeowners may acquire a lower interest rate, saving themselves lots of money across the life of their loan. Or they may unlock equity in their home to cover an upcoming large purchase, such as home improvements. Before taking this step, however, it is important for homeowners to learn all the key things to know about refinancing a home loan. Get started with this guide.

For informational purposes only. Always consult with a licensed mortgage or home loan professional before proceeding with any real estate transaction.

Refinancing Comes with Potentially High Costs

Before homeowners refinance their home loan, they must make sure it is financially viable by looking at the costs. The potential expenses vary according to the loan balance and lender fee schedule. Most lenders charge between 2 and 4 percent of the total amount due on the loan for this service.

Homeowners who owe $200,000 on their home, for example, will pay about $8,000 to refinance with a lender who charges four percent. If the lender only charges two percent, however, then the total fee for the service will be $4,000 instead.

Some lenders provide a no-cost refinance loan to save their clients from paying a lot upfront. With this loan, the lender covers all closing costs and fees for the homeowner, though they usually make it up with a higher interest rate.

Homeowners can shop around to find a lender with the best rate when considering refinancing. They should ask about all fees and other costs before applying, so they do not waste any time and effort. Many lenders are open to negotiations as well, giving homeowners a chance to eliminate some of the fees.

Finances Need to Be in Good Shape to Secure Optimal Terms

In order to secure their ideal terms, homeowners need to have their finances in optimal shape. They need to have a credit score of 760 or above, for example, to secure the lowest interest rate possible. With a high credit score, lenders can rest assured the homeowner poses minimal risk of default, allowing them to secure better terms.

A debt-to-income ratio of 36 percent or lower is also helpful in qualifying for the home loan terms they want. Certain lenders may allow for a debt-to-income ratio of 43 percent instead, though the terms will not be as good. If their ratio is too high, homeowners may need to pay down their debt as much as possible to qualify for refinancing.

Home Equity Plays a Role as Well

When it comes to conventional refinancing options, home equity is an important part of the equation. In order to qualify for the new loan, homeowners must have at least 20 percent equity available. Otherwise, they do not have enough of the loan paid off to satisfy the lender's requirements.

Without equity, the only way to refinance is through government programs. However, the homeowners must meet all the terms of those programs to participate.

They can check with potential lenders directly to learn about their eligibility requirements and available terms. With that information, homeowners can decide if refinancing is the right move for them.

A Fixed Rate Loan May Be Better Than Adjustable Options

When refinancing, homeowners are often better off selecting a fixed-rate loan over the adjustable options. With adjustable-rate loans, the interest rate fluctuates with the market, which also changes the monthly payment amount.

The number of times the rate adjusts each year varies from lender to lender as well. Some loans may only adjust once a year, while others change every six months. This can leave homeowners uncertain about what to expect from their mortgage, leaving their finances on shaky ground.

Fixed-rate loans, however, come with a steady interest rate that never changes across the life of the loan. The monthly payment can still change a bit, however, if they pay their property taxes and homeowners' insurance through their lender. The fixed-rate arrangement makes the monthly payment much more stable overall.

Reasons to Refinance Your Mortgage

Along with understanding how refinancing works, it's also important to know your reasoning for doing so. Here are some of the more common reasons that people refinance their home loans.

You Want to Change the Term Length

If you want to change the term length of your home loan, consider refinancing. It's an opportunity to better tailor your mortgage repayment plan according to your current financial situation.

Refinancing is not only beneficial for those who need longer terms; it's also great for those who prefer shorter ones. If you refinance and take out a 15-year loan instead of a 30-year one, you'll likely end up paying less in both the long and short run as opposed to if you had stuck with the original 30-year loan.

You Want to Consolidate Debt

Consolidating debt allows you to combine multiple loans into a single loan with a lower interest rate. By refinancing your home loan and consolidating these unpaid balances into one low-interest loan, you may be able to free up extra cash each month and save money long-term.

You Want a Lower Interest Rate

By refinancing to secure a lower interest rate, homeowners can reduce their monthly mortgage payments. The total amount of interest paid over the life of the loan decreases as well.

With less interest to cover, homeowners can speed up paying off the actual balance of their loan, reducing their loan term. To make it all worthwhile, homeowners should aim to reduce their current interest rate by at least 1 percent, though 2 percent is better.

You're Planning On Renovating

If you're planning on renovating, refinancing can help you access the funds needed for your project. Providing you have enough equity, you can do a cash-out refinance. This is when your new mortgage is more than your existing one, and the excess funds can then be used for expenses like renovations.

Should You Refinance Your Home Loan?

When homeowners take all the above into account, they can secure their ideal terms while refinancing their home. All they have to do is shop around to find a lender who can offer them the best deal.