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A person usually considers a refinance when they need to change the terms of the loan they purchased to make it easier to manage their mortgage. This article will help you understand what a refinance is and how it works.
What is a Refinance?
When a person reviews the terms of their mortgage loan and needs a new agreement, they may have to refinance. They may want to lower their current interest rate, or to change their payment dates, or simply need to have the terms of their loan modified due to their current economic conditions.
A refinance is when a new loan replaces the loan you are currently paying. Depending on the type of loan, you may get a new interest rate, a new repayment term or a different principal balance.
There are two types of financing:
- Term and Rate Refinance
- Cash-out Refinancing
Term and Rate Refinance
With this type of refinancing, you can change the interest rate or the term you have to pay off the loan. Increasing the payment term allows you to pay less money per month, or save money on interest by eventually making larger monthly payments.
You may also have access to a lower interest rate. This type of refinancing does not change the amount of money you originally borrowed.
A cash-out refinance is when you take the accumulated cash out of your mortgage. That is, the amount of money you have deposited for your mortgage payment from the down payment to the monthly payments you have made so far.
This type of refinancing allows you to withdraw that equity and use it to pay off other types of debts. Simply put, it allows you to obtain cash by increasing the principal balance of your mortgage.
Regardless of the type of refinancing you are interested in, you should know that not everyone is qualified to get a refinance. Depending on the lender, you have to meet certain requirements in order to get one.
Consider the following factors before applying:
- Credit Score: Just like when you acquired your first mortgage loan, lenders do an analysis of your credit history and credit score. You need a certain score to qualify for refinancing.
- Equity: in your current home. Lenders usually require that the equity in your home be greater than the cash you need to drawdown. The amount required depends on the lender’s policies and loan program.
- Debt and Income: The lender reviews your debt-to-income ratio. The less debt you have at the time you apply for a refinance, the more likely you are to be approved.
When Should you Refinance Your Mortgage Loan?
Lower interest rates
Mortgage loans are loans that you commit to for the long term. They are usually paid off over 15 to 20 years. During these years, interest rates may vary. A situation could arise where at the time you were approved for your mortgage loan the interest rate was 12% and current economic conditions have caused interest rates to drop. This may be a good time for you to apply.
When you need to pay more or less money per month
Needing to pay smaller monthly amounts is a good reason to apply for a refinance. This allows you to have a loan with a longer term and, therefore, be able to make a smaller payment each month.
Pay for unforeseen events or emergencies
Sometimes we need an amount of money to cover emergencies or large expenses that came up unexpectedly. A refinance can help you cover other types of debts with the money you have accumulated over the time you have been paying on your mortgage.