You already have a mortgage, so you assume you know everything about refinancing. This may not be true, though. There are some differences between a purchase mortgage and a refinance mortgage. Before you start the process, familiarize yourself with these terms. This will enable you to know the right questions to ask your lender when you refinance.
Rate and Term Refinance
A rate and term refinance is a loan you take out to strictly lower your interest rate or change your term. You use the new loan to pay off your existing loan. You can use this program for any type of refinancing including ARM to fixed rate; fixed rate to ARM; or fixed rate to fixed rate. No matter the terms, you cannot take cash out of the equity of your home with this program.
Cash Out Refinance
A cash out refinance is when you take cash out of the equity of your home. Most of these loans are fixed rate loans only. They allow you to take up to 80% of the equity in your home out with the loan. You can take the cash that exceeds the amount of your outstanding principal. You can take it in one lump sum or have the closing agent pay off specific debts, such as credit cards right from the proceeds.
The amortization shows you how long it will take to pay off the loan. If you took out a 30-year term, you would have an amortization table that shows 30 years’ worth of payments. On this table, you will see the amount of principal and interest you pay each month. This can help you if you plan to pay your loan off faster than the intended term.
The amount you have invested in the home is your equity. You can figure out how much equity you have by taking the current estimated value of your house and subtracting any outstanding principal balance you have outstanding. Let’s say for example your home is worth $300,000 and you have a $200,000 mortgage on the home. In this case, you have $100,000 in equity.
Even though you already have a mortgage and just want to refinance, there are still costs to pay for the work done on your loan. These closing costs work much the same way as they did in your purchase loan. You pay the costs at the closing in the form of cash or a cashier’s check. In some circumstances, you can wrap the costs into your loan. This increases your principal balance and makes the necessary cash at closing decrease.
The LTV or Loan-to-Value Ratio is the amount of money you borrow compared to the value of the home. For example, if you borrow $200,000 on a $300,000 loan, your LTV equals 67%. The lower your LTV, the higher your chances of approval on a refinance. This is because a lower LTV means you have more of your own money invested in the home.
The principal of your loan is the money you borrow. It does not include the interest. On your amortization table, you will see the amount of principal you pay each month. In the beginning of the term, this amount is much lower than the interest. As the years go on, you start to pay more principal than interest.
Debt to Income Ratio
Just as when you purchased your home, you have to prove that you can afford a refinance. The lender verifies this with your debt-to-income ratio. They calculate your gross monthly income and divide it by your monthly debts. These debts include your mortgage, credit cards, student loans, car payments, and any personal loans. The mortgage includes your principal, interest, taxes, and insurance. The higher your debt ratio is, the riskier your loan.
Every lender you apply for a refinance with must send you a loan estimate within 3 business days of the application. You should use this Loan Estimate to compare different offers from various lenders. On this document, you will see the various costs the lender will charge you for the loan. It is one of the tools you can use to find the best deal for your refinance.
Truth in Lending
The Truth in Lending document shows you the interest rate as well as the APR which includes all of the closing costs for your loan. This gives you an accurate picture of how much the loan costs you over the life of the loan. It also helps you to determine which loan is the best deal for you.
Mortgage Terms Slightly Differ for Refinances
It is important to realize that the mortgage terms differ slightly for a refinance. You no longer have to worry about down payments or seller’s credits. What you have to worry about is how you qualify for the loan and what lenders charge. You want to find the loan that has the best rate along with the least expensive closing costs. Sometimes you may want to opt for the higher closing costs in exchange for the lower interest rate. You have to do the math to see how long you plan to stay in the home and which loan will cost the least amount in the end.
Understanding these mortgage terms can help you have a knowledgeable conversation with potential lenders. You will have a better chance at understanding the numbers the lender throws at you so that you can make the choice that is right for you.