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995 Fifth Avenue, #5N (Compass) 995 Fifth Avenue, #5N (Compass)
Once you manage to get a mortgage, refinancing may be the last thing on your mind. After all, acquiring a mortgage can be a stressful process one simply doesn’t want to revisit. However, there are times when refinancing can be a highly advantageous strategy. The trick is knowing why, when, and how to refinance so you don’t end up losing money or damaging your credit score in the process.

According to the Mortgage Bankers Association, the United States' national association representing all facets of the real estate finance industry, refinancing application volume has skyrocketed over the past few months due to very low interest rates. However, the rates have begun to rise at the onset of the new year.

Refinancing Defined

The process of acquiring a new mortgage to replace an existing mortgage is called refinancing. Refinancing is generally done when a borrower wants to obtain a better interest term or rate. Refinancing is sometimes done when a borrower needs to access additional money for a major home repair or another costly project. While refinancing can be strategic for people with strong credit histories, for those with less than perfect or bad credit histories, it can be a risky endeavor.

Why to Refinance

There are many reasons to refinance, but the most common reason is often a desire to shorten the term of your loan. Let’s say, you originally signed on to a 30-year mortgage over a decade ago, but now have substantially more money available and want to pay off your mortgage more quickly. By refinancing, you might reduce your remaining payments from 20 to 10 years and if you do, you’ll play considerably less interest and as a result, potentially save tens of thousands of dollars. But reducing the length of your term isn’t the only reason why people opt to refinance.
Another common reason to refinance is to take advantage of lower interest rates. If you locked yourself into a high-interest rate loan at 7% but can now refinance at nearly half that rate, there is good reason refinance and much to gain from doing so. On a related note, if you can lock into a lower interest rate, you may also be able to significantly lower your monthly mortgage costs. This may help you endure a period of difficult finances or conversely enable you to move more money into home repairs or retirement savings.
Another common reason people refinance is to switch from an adjustable-rate mortgage to a fixed-rate loan. If you originally opted for an adjustable-rate mortgage, you never know what is going to happen next as rates can rise over time. When interest rates are low, it is nearly always more advantageous to lock into a fixed-rate loan, even if it means refinancing.
The final reason to refinance doesn’t entail lowering your term or interest rates but rather borrowing against your home equity to complete a major home repair. While this can be a great way to raise the value of your home, you’re essentially borrowing from yourself (e.g., if you only owe $200,000 on your home but borrow $50,000 to complete a renovation, you’ll be back to owing $250,000 on your home).

When to Refinance

When it comes to mortgages and refinancing, it’s all about the numbers, but there are two sets of numbers you need to consider here: Your potential savings and how refinancing will impact your credit score.
Everyone’s situation is unique, and this is why it is important to crunch all the numbers or work with a professional to crunch the numbers for you. First, if you’re refinancing to lower the length of your term or to lower your interest rate, find out exactly how much you stand to save in the process. Bear in mind that if you’re refinancing, there will likely be closing costs on the amount borrowed, which generally run from 2% to 3%.
Second, it’s important to consider how refinancing your mortgage will impact your credit rating. First, as is the case with any loan, if you’re refinancing, your lender will check your credit score and this will trigger a hard inquiry, which may impact your score. If your refinancing takes the form of a home equity loan (you’re borrowing against your own home equity), you’ll also lower your credit score because the refinancing will negatively impact your debt to credit ratio.

How to Refinance

If you’ve weighed the pros and cons and still want to refinance, the process generally involves four steps.

    First, shop around for refinancing options:

    The higher your credit score, the more options you’ll find and the better the rates will be. A few lenders will offer no-closing cost loans, but beware—these generally come with much higher interest rates and may not be the best option.

    Second, determine your level of home equity:

    If your home’s value has increased significantly since you closed, you may have a lot more equity than you think. On the other hand, if your home’s value has depleted, you may realize that it is not a good idea to refinance.

    Third, anticipate an appraisal:

    Many lenders require a home appraisal to determine the home’s current market value. During this stage, be fully transparent about any additions or improvements you’ve made to your home since purchasing it. If you’ve updated the kitchen, bathroom, or replaced old floors, these improvements should be noted.

    Fourth, prepare for your cash for close requirements:

    Before you close on the new mortgage, you’ll need to prepare to cover any cash needed to close the deal. How much you owe at closing will depend on a wide range of factors from your location to your current credit score. According to LendingTree data, the nationwide average in 2017 was $4,876 per transaction, but in New York City, you should expect the closing cost to be higher given that most home loans are also higher.

Whether you choose to refinance is always a matter of weighing the potential gains against the potential cons. What matters most is the potential long-term return and potential impact refinancing may have on your current credit rating.
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Contributing Writer Cait Etherington Cait Etherington has over twenty years of experience working as a journalist and communications consultant. Her articles and reviews have been published in newspapers and magazines across the United States and internationally. An experienced financial writer, Cait is committed to exposing the human side of stories about contemporary business, banking and workplace relations. She also enjoys writing about trends, lifestyles and real estate in New York City where she lives with her family in a cozy apartment on the twentieth floor of a Manhattan high rise.