Mortgage refinancing is a strategy used by real estate investors to pay off their loan faster or lower their mortgage payments. It involves switching your current mortgage for a new one that has better terms.
In the past month, there has been a surge in refinance applications in the US housing market 2020. This is connected to the coronavirus outbreak. In an attempt to protect the housing market from suffering lasting damage from the COVID-19 pandemic, the US Federal Reserve announced an emergency federal funds rate cut on the 15th of March. This resulted in an interest rate of between 0% and 0.25%. These federal funds rate cuts do indirectly affect home and investment property mortgage rates. So many real estate investors are now rushing to banks to refinance rental property to take advantage of lower rates.
A Quick Overview of the Steps of Refinancing a Mortgage
Here is the process of refinancing a mortgage in 2020:
- Have a clear financial goal – You need to have a clear reason to refinance rental property, whether it is to shorten the term of your loan, lower monthly payments or leverage equity for debt repayment or property repairs.
- Examine your credit score and history – To qualify for a refinance, you need to get approval from your mortgage lender. A good credit score enhances your chances of getting approved to refinance a house and enjoy favorable rental property mortgage rates. If your credit score is poor, it would be advisable to work on improving it first before beginning the refinance mortgage process.
- Check your real estate equity – Equity is the difference between the actual market value of your income property and your current mortgage balance. For example, if your property is worth $400,000 and you owe $250,000 on the mortgage, your real estate equity is $150,000. When refinancing a mortgage, lenders usually offer better rates when you have at least 20% equity.
- Shop multiple lenders – Get quotes from as many mortgage lenders as possible. Compare their interest rates and the cost of fees before you make a decision.
- Apply for loans – The application process for refinancing can be very time-consuming and in 2020, it may be delayed even more because of the ongoing situation. You will have to provide lots of information about yourself and your finances. Most lenders will want to see your recent bank statements, federal tax returns, any stubs, and other relevant documents.
- Make a decision – Most lenders will respond within days with information about any available loans. Use a loan calculator to run some numbers and decide which loan works best for you when refinancing a mortgage.
However, before starting this process, you need to weigh the pros and cons of refinancing a mortgage.
Pros of Refinancing a Mortgage
When is it worth it to refinance? When you want to pay lower rates, clear your loan faster, leverage your equity or avoid unnecessary fees.
Lower refinance rates
This is one of the main advantages of refinancing a mortgage loan. You can pay less by changing your adjustable-rate mortgage to a fixed-rate mortgage. The money you save by refinancing can be used for buying a second investment property.
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Paying off debt faster
Refinancing enables you to pay off your loan in less time. For instance, changing a 30-year loan to a 15-year mortgage implies that you will finish paying your debt much faster. This also allows you to build equity in your investment property much faster. The only challenge is that you will have to spend more cash on monthly payments, which can put a strain on your finances if you are not prepared.
Cash out your equity
A cash out refinance allows you to leverage the equity on your investment property. This basically involves borrowing against your equity and refinancing for more than your current mortgage balance. The extra money can then be used to clear your loan, start a business, renovate your investment property or save for your children’s college education.
Eliminate private mortgage insurance
If you paid less than 20% for down payment on your first loan, then you have probably been paying private mortgage insurance (PMI) on each monthly payment. Refinancing with home equity above 20% allows you to avoid this extra fee.
Cons of Refinancing a Mortgage
Most mortgage lenders have very strict requirements for real estate investors applying for refinancing. If something small is amiss, your chances of getting approved will be very slim. Your lender will scrutinize your financial information thoroughly before making a decision. If you’ve experienced a reduction in salary or your credit score has dropped, it could result in your refinancing application being rejected.
Higher loan payments
Let’s say you are approved for a 30-year loan to replace your current 15-year loan. Though your monthly payments will be low initially, the cost of refinancing a mortgage will be higher in the long-term.
Costs of refinancing
Refinancing is not free. Just like conventional loans, it comes with costs such as home appraisal fees, loan origination fees, credit report fees, taxes, and title insurance fees. Put together, these costs could add up to between 3% and 6% of the mortgage balance. In most cases, these fees are paid out-of-pocket at the closing stage. You can use a loan calculator to establish how long it will take before you break even. For instance, if you are paying $3,000 in closing costs and you are saving $300 a month on your mortgage payments, it will take you 10 months to get to a break-even point.
Low property appraisal
Lenders usually conduct home appraisals to assess what an investment property is worth. The property’s value is often based on comparable sales (real estate comps) in the neighborhood. A low appraisal of your investment property will wreck your chances of getting a new mortgage with favorable terms. If the appraiser reckons that your property is worth much less than the amount owed, the lender will decline your refinancing request.
Some lenders will charge you an additional fee for clearing your mortgage amount early. If this prepayment penalty is high, it would make sense to stick to the original loan.
Though refinancing a mortgage is not a simple process, it is one of the best strategies for lowering your mortgage payments. If you are involved in real estate investing, all you need to do is keep your credit score high, have cash on hand for mortgage costs, and find the right lender. With the current mortgage rates in 2020 due to the coronavirus pandemic, now could be the best time to apply for a mortgage refinance.
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