Photo by Nansan Houn from Getty Images Signature via Canva.com
In this article:
Securing a mortgage is no easy feat, especially for first-time military homebuyers who need home financing options. Later, when the time is right, refinancing the mortgage to reduce interest payments or shorten the loan term might be a smart money-saving option. However, the VA refinancing loans process (as well as conventional loans) can be just as stressful as the original loan process without adequate preparation.
The mortgage lender set the initial terms of the home loan by assessing the homebuyer’s financial situation and the national interest rate at the time of application. But what if those terms have changed over the years? Investigating a loan refinance might be beneficial.
It takes some mathematical sleuthing to see if the fees are less than the ultimate savings. But with the help of a refinancing calculator and professional guidance, refinancing might be worth the hassle.
What Is Refinancing?
Refinancing sounds like simply applying to convert to more favorable terms, but actually, the initial loan is paid in full, and a new, second loan with better terms is obtained.
Because it’s a new loan application, the refinancing process requires the borrower to collect the same essential financial documents as for the original loan and to obtain an appraisal of the property’s current value.
To apply, gather the latest versions of:
- Financial assets such as retirement and savings accounts
- Verifiable employment and income histories
- Credit scores and reports
- A recent home appraisal
When Is the Best Time to Refinance?
As a starting point, most lenders require the original mortgage to be held for at least 12 months, but there are some variations. If more favorable interest rates are the goal, assess all credit history and scores to correct errors. This is also true for other financial accounts if income has changed.
When considering refinancing, it is not the time to cosign a loan for a family member, buy a car, or make any purchase that changes the borrower’s financial situation. These debt-inducing transactions reduce the ability to qualify for the lowest interest rates.
Knowing the tipping point or break-even numbers will help gauge the best time to refinance. This is a tricky feat that requires thorough preparation and a professional mortgage lender’s help.
How to Prepare for Refinancing
Preparation is more than just gathering documents. Here’s where the math sleuthing begins. Finding an easy-to-use online refinance calculator helps to keep the numbers in perspective.
Learn to feel comfortable shopping for and understanding new loan terms, including interest rates and associated fees. It’s common to receive favorable refinancing terms from the lender who offered the initial mortgage, because they’d rather retain the customer than lose the loan altogether.
After contacting possible lenders (compare multiple offers side by side to choose the best option), they will provide a loan estimate with the terms, projected monthly payments, closing costs, and other necessary fees. Save early to pay cash for the fees; this helps to lower the overall payment.
The following scenarios are typical money savings versus costs decisions to consider before starting the refinancing process.
Is there a clause in the loan that penalizes prepayment of the mortgage? The penalties vary, so verify how much it will cost to pay early.
Consider future tax returns. When claiming mortgage interest on a tax return, a refinanced rate results in a lower deduction for mortgage interest.
A refinanced loan probably translates to a longer term, even at a lower rate and smaller payment. This means the borrower will pay interest for much longer than the initial mortgage required. Remember that loans are designed to add the most interest in the early payments. Later in the life of the loan, payments are pushed more toward principal.
The new loan will be laden with fees: application, appraisal, title searches, legal, origination, and insurance fees are all possibilities. Adding these up will help determine if the refinancing process is profitable.
return to top
Photo by Karola G from Pexels via Canva.com
5 Reasons Borrowers Refinance
More often than not, borrowers hope to refinance their loan to capture a lower interest rate, likely saving thousands of dollars in interest over the years and possibly shortening the length of their loan.
But there are other reasons, including tapping into equity for home improvement projects and discontinuing private mortgage insurance (PMI).
Ultimately, the goal is to lower mortgage payments while offsetting potential refinancing fees as quickly as possible.
1. Reduce Interest Rate and Loan Term
When researching refinancing options, read about a “rate-and-term” refinance because it's the most popular way to save money.
The goal is to simultaneously reduce the current interest rate and the loan term (likely from 30 years to 15), potentially saving thousands of dollars over the life of the loan. Don’t forget about the fees mentioned above, and that to max out these savings, the monthly payment will probably increase.
2. Refinancing an Adjustable Rate Mortgage
If the loan is an Adjustable Rate Mortgage (ARM) and it’s scheduled to increase, it’s worth investigating if it's possible to qualify for a lower interest rate than the planned bump in rate. It's also possible to refinance an existing ARM for a new one with a better payback schedule.
3. Cash-Out Refinancing
Cash-out refinancing is available by withdrawing equity (the difference between the loan amount owed and the property's value). This type of refinancing is a logical option if the equity is significant or the loan is fully paid.
Homeowners use this money for many reasons, including down payments on another house, home improvements, and paying off other debt. Remember that with this option, the refinance loan amount is larger because it equals the equity the homeowner is taking out.
4. Cash-In Refinancing
Cash-in refinancing is different because it applies for a lower interest rate, a shorter loan term, or the choice to put more money down during the refinancing to avoid mortgage insurance.
Basically, a lump-sum payment is swapped for the current mortgage, with a new mortgage at a smaller principal balance.
5. Reducing PMI Payments
Some borrowers refinance their home loans because they pay for private mortgage insurance (PMI) and want to reduce PMI payments. With a new, refinanced loan, it's possible to reduce those monthly costs. Another way to save and eliminate PMI is to refinance an FHA loan into a conventional mortgage after building 20% equity in the property.
VA Refinancing Loans
There are two main VA loan refinancing options for veterans: the VA Streamline Refinance, also known as the Interest Rate Reduction Refinance Loan (IRRRL), and the VA Cash-Out Refinance.
VA Streamline Refinance
Homeowners with a VA loan who want a lower interest rate to reduce monthly mortgage costs can apply for the VA Streamline. These loans require less paperwork (often without an appraisal) and allow borrowers to roll most closing costs into the loan.
VA Cash-Out Refinance
Many veteran homeowners with substantial home equity use this refinance option to take out cash. They can use the money for home improvements or to reduce debt.
Refinancing your mortgage isn’t a one-size-fits-all, completed-in-one-day kind of deal. However, by collecting the necessary information well in advance, continuously monitoring the housing finance markets, and even maintaining an open relationship with a lender, the benefits of a refinanced deal could handsomely outweigh the annoyance of the process.
By Dawn M. Smith