Getting into a mortgage with any lender is a big step. Essentially, you’re promising to maintain a relationship with this business that lasts longer than many marriages. And like marriages, you’ll find that you’re not the same person you were when you first entered into this contract after a few years down the road. Thankfully, because circumstances change (as well as the market), you’re not stuck with the same contract you signed ten years ago due to the option of refinancing. But wait, do you really need to wait ten (or more) years before you can get a better rate? How soon after buying a house can you refinance?
The terms of your home loan will stipulate when you’re able to refinance it. Look for clauses that include terms like “Prepayment Penalty” or “Seasoning/Holding Period” as they’ll be the deciding factor for what timeline you have to abide by when refinancing. Commonly, you can refinance after about 6 months.
I’ll cover all of that shortly. First, let’s talk about why anyone would want to go through the hassle of refinancing, what types of loans are eligible to refinance, plus more about the clauses that might keep you in refinancing limbo.
Why Would Someone Refinance a Mortgage?
Mortgages are one of the best long term loans to get as they often have low interest rates. Banks will often give homeowners these low rates due to the fact that they expect to keep a decades-long relationship with their customer. But it’s not entirely due to goodwill, the money the bank earns over a 30-year mortgage even at less than 10% interest, is still a win for them.
Banks have to walk a thin line between finding an interest rate that’s reasonable for the customer, but still brings revenue for them. Most homeowners with decent credit would run screaming from a bank that offered the same interest rate they do for credit cards like 18%. So, since the bank realizes you’re beholden to them for a few decades, they lower the interest rate to something more manageable like 8%.
However, just because you lock in a certain interest rate at the time of closing on your home doesn’t mean that you’re stuck with it. Factors including your assets, credit history, employment status, and other variables affect the interest rate banks will offer.
As homeowners begin to accrue equity, pay down credit card debt, and get higher-paying jobs it’s a good idea to shop around to see if you can get a better rate for your mortgage.
If you find a more competitive rate with a new lender, be aware that they’ll usually refinance only about 70% of the original mortgage. Since you’ll rarely get 100% financing, it’s especially important that you try to knock out as much of that 30% left as possible before refinancing. That way, you’re not on the hook for two monthly mortgage payments.
The Different Types of Loans Used to Buy a Property
Not all homeowner loans are the same, but they can be refinanced one way or another. Let’s break down the types of loans available for potential homeowners or real estate investors looking to buy a property:
- Government-backed loans like FHA or VA loans. These have specific requirements that need to be met before a potential homeowner is eligible for them. If you qualify for a government-backed loan, you can expect some serious perks like lower down payments, lower interest rates, and easier credit terms.
- Conventional mortgages. If you don’t qualify for special government programs, you’ll most likely end up with a traditional mortgage through your bank or credit union.
- Hard money or private loans. These types of loans aren’t mortgages and will rarely cover the total purchase price of a home. Private lenders’ hard money loans carry a higher interest rate than traditional mortgages as they’re used more for gap funding for things like repairs and upgrades.
How Soon After Buying a House Can You Refinance?
While all of your loan options can be refinanced, that doesn’t mean it’s as cut and dry as you might expect. There are a few roadblocks that may prevent you from refinancing, so it’s critical you read the fine print of your loan.
In particular, look out for these terms:
As a homeowner, you’re responsible for a lot of moving parts. From closing on the home to maintaining it, homeownership isn’t an easy job. The same goes for your lender; it’s not as easy as you might think for them to fork over hundreds of thousands of dollars. There’s a lot of work that goes into issuing a mortgage, which is why prepayment penalty clauses may show up in your contract. This penalty is the legal equivalent of your lender saying, “Look, we’re doing a lot of work to make this mortgage happen for you. If you don’t hold onto this loan for a certain amount of time, then we’re going to make you pay a little more to recoup our costs.”
Luckily, prepayment penalties are more common on commercial properties than residential. Still, make sure you or your attorney keeps an eye out for a penalty clause before signing on the dotted line.
“Seasoning” is a term used in refinancing contracts; you’ll rarely see it in your original mortgage. Seasoning, or a holding period, will be added as a clause to refinancing contracts as a way for the lender to make sure you’re holding onto the property for a set amount of time.
For them, it’s similar to prepayment clauses: they want to ensure that you’ll be holding onto this property for a little while and not just making them do all this work for nothing. Luckily, a seasoning period isn’t very long; expect to see it run anywhere from 3 months to 1 year.
It’s always crucial to read the fine print of your legal contract with the lender. If you don’t see specific clauses related to prepayment or seasoning, specifically ask or have your lawyer look it over.
If you’re dealing with the original loan, ask, “Is there a prepayment penalty?” If you’re looking to refinance, ask your new lender, “Is there a holding period on this loan?”
How Do Real Estate Investors Use Refinancing?
Successful real estate investors will utilize refinancing to reduce their total debt load. Most investors will seek out a hard money lender at some point to help get them over the gap between the money they have and the money they need.
Hard money is much easier to get than a traditional mortgage, as most lenders won’t care about your credit score or employment history. That said, they will mitigate their risk by charging higher interest rates and having a much shorter payback period. When a real estate investor gets a hard money loan, they’ll look to pay it back as quickly as possible by refinancing it with a conventional lender.
There’s a little more nuance to this because this refinancing strategy will often result in a BRRR-style loan. BRRR (pronounced “burr”) stands for:
I have a blog post and video that do a much deeper dive into BRRR loans, but what’s important to understand here is that savvy real estate investors will use refinancing to leverage their position with as little of their own money as possible.
Refinancing your home loan is a great way to use your growing experience as a homeowner to your benefit. Whether you’re looking to get a better rate on your home mortgage or are seeking a way to increase your profit on a real estate venture, refinancing is a critical component for any property owner.
What tips do you have when it comes to refinancing a home loan? Leave a comment and let us know.