You may have been hearing the term “refinancing” a lot more lately (since rates have been at a near all time low). However, what does it mean to you as a homeowner? It’s actually a very important aspect of homeownership that could save you thousands of dollars if handled properly.
What is a Mortgage Refinance
A mortgage refinance is when a homeowner replaces their existing loan with a new one. Homeowners will refinance their home for a variety of reasons whether it be to get an improved interest rate, get a more manageable monthly payment, get cash out of their home, etc. However there are different types of refinances and not each one is equally beneficial depending on the motivation of the refinance.
Reasons People Refinance
There are so many different reasons people refinance their mortgage. Some are more popular than others. Some of the most popular reasons people refinance are:
- A Reduced Interest Rate
- Get Cash Out of Their Home
- Financial Hardship
- Increased Income
A Reduced Interest Rate
There are many ways that a homebuyer can get a reduced interest rate. Mortgage rates may be down overall, your credit score may have improved, and more. Influences like these can lead to a lower interest rate which can reduce the amount of total interest you spend over the life of the loan. A good rule of thumb is to consider a refinance if your interest rates reduce by at least 1%. However, a professional can provide more insight. Homeowners that want to save money will benefit from getting a reduced interest rate.
Get Cash Out of Their Home
When people want to get cash out of their home, they will look into a mortgage refinance. Some types of refinances can tap into the home’s equity. The funds are given to the homeowner during the close. The amount of money you are able to access depends on the amount of equity you have.
When people are dealing with financial hardship, they may turn to a mortgage refinance to better manage their budget. There are plenty of types of refinances and they can provide options for different rates and terms.
When people are put into a better financial position then it may make sense to update their budget. Updating a budget can mean getting a mortgage refinance to better tackle a home loan. Proper financial management when more money is coming in is key to improving your overall financial health.
Different Types of Mortgage Refinance
There are many different types of refinance but four of the most common are:
- Rate-and-Term Refinance
- Cash-Out Refinance
- Cash-In Refinance
- Streamline Refinance
This is what is considered a “typical refinance”. A rate-and-term refinance allows the borrower to replace their current mortgage with a new one that has updated terms and conditions. You can expect your interest rate, loan repayment term, and monthly payment to be different. Homeowners that want to save money will usually go with this option.
When homeowners want to get cash out of their home they will choose to get a cash-out refinance. Instead of the new loan replacing the current loan for the remaining amount on the original loan, it will take into consideration the value of home. This provides the opportunity for homebuyers to access their equity with a new loan amount for more than the original remaining balance.
When homeowners want to improve their Loan to Value (LTV) ratio then they will generally choose a cash-in refinance. In this refinance, homeowners will provide extra funds during closing to go towards the amount due to the lender. When the homeowner reduces this overall amount, the LTV can improve. Homeowners usually have a goal milestone in mind to reach 20% of equity in their home to get their LTV to be 80%. When this happens, homeowners may be able to get rid of their private mortgage insurance (PMI) with some types of loans and qualify for more lending opportunities.
What is a Loan to Value Ratio (LTV)
This is a ratio that is used by lenders as one way to assess some of the risk involved with a borrower. You can calculate your LTV by dividing your mortgage amount by the appraised property value.
A streamline refinance provides homeowners the opportunity to refinance their mortgage without having to go through an appraisal, credit score check, debt-to-income ratio verification or provide proof of income. Homeowners that have lost value in their home are the ones to look at this type of refinance because credit score and debt do not impact the refinance. A homebuyer can only streamline refinance a government-backed home loan. Conventional mortgages are not applicable due to the increased risk that the lender faces.
Negative Equity: What You Need to Know
Negative equity is a term that refers to when the value of the property is less than the remaining amount due on the mortgage. Basically, the homeowner owes more than what the home is actually worth. You can see that you have negative equity if your LTV is over 100%.
How Does Negative Equity Happen?
There are plenty of reasons that negative equity can occur. Some of these reasons include:
- Market Decline
- High-Interest Loans
- Small Down Payment
- Poor Condition of the Home
A lot of homeowners deal with negative equity because of this reason. Market decline is when home values decline and it is something that is out of your control but can drastically impact your financial situation. The best steps that you can take is to be an educated borrower. Staying up to date with current home values and market trends can provide you insight and knowledge that you need to make better decisions for your finances. It can always help to discuss with a professional as well!
If a borrower is high-risk, they will deal with inflated interest rates. These high-interest rate loans can result in borrowers accruing more interest than what they can keep up with. If you want to refinance it is good to make sure your credit score is in order. You may need to look at streamline refinances that don’t require a credit check.
Small Down Payment
Many people say a good rule of thumb is a 20% down payment because it will provide you 20% equity upfront. This means your LTV will be 80% which provides a better cushion if there are changes in the market. A small down payment removes this safety net which means you can experience negative equity easily if there are drastic market changes.
Raggedy Condition of the Home
If you do not take care of your home, then the value of the home will decrease. It’s as simple as that. Which is why it is important to make sure that you are up to date on all regular maintenance and home projects. Home values decrease when homes are not properly taken care of.
What Happens if My Home Value Decreases?
If your home value decreases don’t fret. First, figure out the cause. You may especially benefit from talking to a professional during this time. They can provide you insight and help you create a plan to manage your finances moving forward. Once you figure out a cause and a plan, you can begin taking the steps that you need so you can get back on track.
Refinancing When Home Value Decreases
When people find that they are underwater on their mortgage and owe more than what the home is worth, they will typically consider a streamline refinance. These refinances can provide the opportunity to get a more manageable mortgage setup. It is important to note that you will likely face a more complicated loan and process since the lender cannot loan you more than what the home is worth. This can lead you to needing to figure out the difference.
How to Refinance When Home Values Decrease?
Want to refinance your home that has gone down in value? Then there are a few steps that you can take that can make the whole process easier to handle.
Step #1: Get the Current Market Value of Your Home
If you have the funds, you can do this by getting an appraisal. This will let you know exactly how much your home is worth, and could even save you a step down the line. Since appraisals cost money, homeowners can also estimate the value of the property by talking to a real estate agent or looking at similar properties online to get a rough idea.
Step #2: Get in Touch with Your Current Lender
You should discuss the fact that your home value dropped and you are now considering a mortgage refinance. This information will provide the lender a better idea of how to best help your situation.
Step #3: Check Out Federal Mortgage Assistance Programs
There may be refinance programs or options that are available to help you. You can review housing programs by contacting your local public housing authority (PHA). There are also refinances that you can consider. These are referred to as streamline refinances and they are a government-backed mortgage option that can help those in need. You may be able to qualify for assistance that can help you better manage a home loan.
A mortgage refinance may be able to be beneficial depending on your current situation and the type of refinance you choose. There are plenty of reasons that people choose to refinance from wanting to save money, get cash out of their home, deal with financial hardship, and so on. There are a variety of refinances to choose from so make sure to do your research! If you find that you are underwater on your mortgage and owe more than the value of your home then speak to a professional to come up with a plan as soon as possible. You may want to consider a streamline refinance. This is a refinance option that could potentially give homeowners the chance to refinance their home with no appraisal, credit check, debt-to-income verification, or proof of income.
Commonly Asked Questions
Should I Refinance if My Home Value Has Decreased?
That depends. If your home value has decreased slightly and you are not underwater on the loan, then you may need to look for some additional motivation to refinance. However, a refinance may still be beneficial regardless if your home lowered in value or not.
Can You Refinance During a Housing Crash?
You can refinance during a housing crash if you want to. However, whether or not it would be beneficial will be for you to decide. You can use free online tools to see if a mortgage refinance may be able to save you money in the long run.
Should You Refinance Your Mortgage When Interest Rates Rise?
It is important to not look at one factor when deciding upon a mortgage refinance. You should make your decision not on whether interest rates are rising but by looking at the overall benefits of the refinance, how long it will take to reach your break even point, etc.
Is Loan to Value (LTV) Important?
Yes! This is a very important ratio because it provides insight to the lender. In a perfect world, everyone would be a great borrower. Unfortunately, that isn’t the reality so lenders need to be able to assess some risk involved. If you do not qualify for conventional LTV standards then there may be specialized mortgage refinance programs available that you are eligible for.
What if I See Other Home Values Decreasing?
You can talk to a local real estate agent to get insight about changes on the market. You can also do additional research online. If you see that other home values are decreasing, you may be able to expect a decrease in the value of your home as well.