How to refinance your Home Loan?
The interest rates on home loans have eased in last few months. In this scenario, many borrowers are considering to refinance their mortgage and capitalize on this opportunity.
In simple terms, home loan refinance means transferring your present loan to another lender. It is also referred to as Home Loan Balance Transfer by some.
Refinancing your mortgage can beneficial for you to lower your monthly payments, save on interest payouts, retire your other high cost debts and most importantly reduce your overall cost. However, refinance is neither simple nor always beneficial as it sounds. It can cost you heavily if you are not aware of the procedure and costs associated with transferring your present loan to another lender.
So you should do the analysis carefully before switching your existing home loan and see if it’s worth refinancing. For this, you can refer our earlier article “Should you refinance your home loan?”
Step 1 : Set your Refinance Goal
As mentioned earlier, there are many benefits of refinancing. You need to set your reason for refinancing right at the beginning as it will be the determining factor in what refinance loan program your lender will offer you.
Step 2 : Find the best refinance option
Once you have established your refinancing goal, you can start looking for refinance options that best suites your requirements. While selecting the best refinance option, keep in mind the costs associated, such as prepayment penalty, processing fee of refinance loan and other costs.
- Prepayment Penalty : Prepayment Penalty is one of the principal costs associated to balance transfer of home loan that you will have to pay to the current lender. Typically, the prepayment penalty range between 2% to 4% of your balance principal due. Generally the motive behind charging a penalty here is the banks don’t want to lose the customers to another bank. This information is always mentioned in the agreement so you should read it carefully while taking a home loan.
- Processing Fees : Another cost attached is processing fee while shifting your loan to another lender. Your new lender will charge you the processing fee on the amount of loan you will be taking. Generally it is in the range of 0.50% to 1% of the total loan amount.
- Other Costs : Your new lender might also ask you to incur expenses for stamp duty, documentation costs such as, No Objection Certificates (NOCs) for your new loan.
Step 3 : Estimate current worth of your home
Lenders provide finance based on the worth of your home. So get a realistic estimate of what your home is worth. While your current lender might have done the professional appraisal of your home before disbursing your loan, the property prices may have changed since then, further, if you have done any significant home improvement, you might like the new lender to take it into account before estimating your home’s current value.
Step 4 : Find Your Loan-to-Value Ratio
The value of your home is extremely important when refinancing because loan-to-value (LTV) ratios are used as one of many bases to determine the amount you can borrow. It becomes even more important if you wish to raise funds retire your other high-cost debt or would like to generate cash from your investment property.
Loan-to-value ratio is the ratio between the loan amount (balance principal) of your mortgage and the appraised value of your home. If you’re refinancing to take some cash out of your property, you will typically be limited to a loan-to-value ratio of 75–80%. If lowering or avoiding fluctuations in your interest rate and monthly payments is your goal, most lenders might allow your new loan balance to be as high as 90% of the appraised value.
Step 5 : Review Your Income and Expenses
Your new lender will review your income and expenses as part of the refinance process. They will compare your total monthly income, before taxes, to your total debt (which includes payments made to loans, credit cards, etc., as well as your future refinanced monthly home payment). This is called your debt-to-income ratio. Typically, lenders will not want your debt-to-income ratio to exceed 40% to 50% of your total gross income, as part of their qualification guidelines for refinance. So, if you wish to generate extra cash from refinancing your home, make sure that your new monthly payment fits within the prescribed debt-to-income ratio.
Step 6 : Get your refinance and close your existing home loan
Now, the final step, get the refinance loan processed with the new lender. You may also have the option of financing your prepayment penalty into your refinanced loan amount. Just be aware that you will pay interest on that amount, if you decide on this option.
Once you get the confirmation from the new lender, go ahead and pay the balance due and associated costs to the existing lender.
Congratulations! you have just successfully refinanced your home loan.
He has authored several analytical articles on personal finance in The Times of India and The Economic Times. Being a finance geek and having been involved with internet since the early days of the medium, he was a great help and source of guidance while formulating personalmoney.in. You can know more about Manish at ManishMisra.com
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