What Is a Refinance?

Refinancing means to change, renew or replace the terms and conditions of a loan with new terms and conditions. Most people are looking for some advantage when they refinance, such as lower interest rate, short term or maybe to buy out another persons interest in the home. You can also use refinancing to tap into the equity in your home for other purposes like consolidating your debt and/or home improvements.

Interest Rate
When you refinance a mortgage loan, you may be able to receive a lower rate of interest. The rule of thumb says if you can get an interest rate that is one to two basis points lower than your current rate, you should refinance. Or, if you are on an adjustable rate mortgage (ARM) then a refinance to a fixed program is a good idea so you can take the worry of the “what if rates rise” question.

Credit Score
Make sure you don't have any late payments with any of your creditors, including your mortgage within the last 12 months. Late payments can lower your credit score. Most lenders want you to have a credit score of at least 620. Credit scores, also known as FICO scores, can range from 300 to 850. You want your score to be as high as possible, which ensures that you receive the lowest rate possible. Lenders use credit scores to determine the likelihood that you will default on a loan obligation.

Debt Ratio
You need to have your debt to income ratios within the guidelines of whatever product you are requesting.  Typically, a Fannie Mae product likes to see a debt to income ratio (DTI) of 45% or less. (monthly debt/monthly income). Make it a priority to pay off any credit card debt prior to refinancing. Having too much debt can affect your credit score in a negative way as well.

Loan Term
Refinancing gives you the opportunity to receive a different term for your loan. If you have a 30-year loan, you can change it to a 15-year loan if the payments are affordable. A shorter term gives you larger payments but you pay less money in finance charges.

Prepayment Penalty
When you refinance, there could be a prepayment penalty. A prepayment penalty is usually assessed to a loan if refinancing takes place within a certain period of time, for example, three or five years after the original loan date. This information can be used to help determine if refinancing is in your best interest.

If you decide to refinance, make sure you are aware of all the fees involved and you receive a good faith estimate (GFE) and truth in lending (TIL) form from your lender.  It's not uncommon to receive an appraisal fee, title insurance, credit report, filing fees and closing costs. Make sure you know how long it will take you to recover your fees. If you decide to move one year after refinancing, it may not be cost effective to refinance. You can determine how long you should stay in your home by dividing your total costs by the difference between your old and new payments.

Reach out to your current lender that is servicing your loan or a lender that your family and friends will refer to research the possibilities of a refinance.

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