If you’re like most people, your home is your biggest investment. So when it comes time to refinance, you must do your homework to ensure you’re getting the best deal possible. This blog post will cover everything you need to know about home refinance—from standard terms and phrases to different types of loans and how to choose the right one.
What is Home Refinance?
Home refinance is replacing an existing home loan with a new one. Typically, people refinance their homes to get a lower interest rate, shorten their loan term, or both. Refinancing can also tap into the equity built up in your home—a process called cash-out refinancing—to use for major expenses like home improvements or debt consolidation.
Standard Terms and Phrases You Should Know
Before starting the home refinance process, you must familiarize yourself with some of the standard terms and phrases you’ll come across. Here are a few key ones to keep in mind:
- Loan amount: This is the total amount you’re borrowing from the lender. It includes the principal (the amount you’re borrowing) and any additional fees or charges.
- Loan-to-value ratio (LTV): This percentage shows how much of your home’s value is financed by the loan. For example, if your LTV is 80%, you’re borrowing 80% of your home’s appraised value. The higher your LTV, the higher your interest rate will be.
- Interest rate: This is the percentage of your loan amount that you’ll need to pay back in addition to the principal. The interest rate will be determined by several factors, including your credit score, employment history, and the type of loan you choose.
- Mortgage points: These are additional costs paid at closing to lower your interest rate. Each point equals 1% of your loan amount. So if you’re taking out a $200,000 loan and paying 2 points, that would equal $4,000 at closing time.
Types of Loans You Might Encounter
People use two main types of loans for home refinancing: adjustable-rate mortgages (ARMs) and fixed-rate mortgages (FRMs). Let’s take a closer look at each one.
Fixed-rate mortgages have an interest rate that remains the same for the entire life of the loan—usually 15 or 30 years. Because borrowers know exactly how much their monthly payments will be for the loan’s entire life, this type of mortgage offers certainty and stability. However, because lenders are taking on more risk with FRMs, borrowers can expect to pay slightly higher interest rates than they would with an ARM.
Adjustable-rate mortgages have an interest rate that changes periodically based on prevailing market conditions. The most common ARM is a 5/1 ARM, with a fixed interest rate for five years, followed by yearly adjustments. Because ARMs offer lower interest rates than FRMs in their initial period, they can be a good option for borrowers who move frequently. Or for borrowers who expect their incomes to rise significantly over time. Both would help them afford any potential increases in their monthly payments.
However, because there’s always a possibility that interest rates could increase significantly after that initial period ends, ARMs can be riskier than FRMs for some borrowers. Especially for those who may not be able to afford those higher payments if they do come about.
When Should You Refinance?
There are many reasons why homeowners choose to refinance their homes, but here are some of the most common ones:
- To get a lower interest rate: This is often the primary reason people refinance. By getting a loan with a lower interest rate, you can save thousands of dollars in interest over the life of the loan.
- To shorten the loan term: Another common reason to refinance is to switch from a 30-year loan to a shorter 15-year loan. While your monthly payments will be higher with a 15-year loan, you’ll also pay off your home much faster—and save money in interest.
- To cash out equity: Some homeowners refinance to tap into the equity they’ve built in their homes. This can be an excellent way to get extra cash for home improvements or other expenses. Remember that you’ll likely pay more interest over time with a cash-out refinance than with a regular home equity loan.
- To consolidate debt: If you have other debts that you’re looking to pay off, you can use the equity in your home to get a cash-out to refinance. This can be an excellent way to save on interest and get debt-free more quickly.
The Bottom Line
Refinancing your home can be an excellent way to save money or tap into the equity you’ve built over time. But it’s not always the right choice—so be sure to research and talk to a financial advisor before making any decisions.
When you’re ready to start shopping around for a new home loan, comparing offers from multiple lenders is essential. Some things to look for include the following:
- The interest rate
- The fees
- The loan terms
Finally, remember that refinancing is a big financial decision—so be sure to think it through carefully before moving forward.