Home Refinancing Guide
Home refinancing pays off your current mortgage and replacing it with a new one.
Why would you do this?
There are several reasons that someone might choose to refinance. Primarily, refinancing your home may allow you to reduce your monthly payments, lower your interest rate, take cash out of your home’s equity, or change the term of your mortgage. You can also move from an adjustable rate mortgage into a fixed one.
Ultimately, refinancing can be a great way to reduce your monthly expenses and the overall cost of your mortgage.
Types of Refinancing
There are a few different types of refinancing that you should be familiar with before going any further.
Cash-out refinancing allows you to borrow more money than you owe on your current mortgage.
For example, say your original mortgage was $250,000. After paying this down to $200,000, your home increases in value and is now worth $350,000.
You can refinance based on your home’s current value by taking out a $350,000 mortgage, paying off the rest of your previous mortgage, and keeping the remaining cash.
Cash-in refinancing is basically when you save up a certain sum of money to pay toward your current mortgage.
This is usually done to decrease your loan-to-value ratio, which can help you qualify for a new mortgage with lower interest rates.
Rate and term
Rate and term refinancing is the most common option. With this type of refinancing, you take out a new mortgage with a new term, interest rate, or both.
For example, you might choose to refinance in order to change your 30-year mortgage to a 20-year mortgage with the same interest rate. Alternatively, you might want to change your 5% interest rate to a 4% interest rate.
In some cases, you’ll be able to decrease both the rate and term. Other cases you’ll change the type of mortgage from fixed to adjustable, or visa versa.
Should You Refinance?
Lower interest rates, shorter terms, reduced monthly payments, etc. With all these benefits, why wouldn’t you want to refinance?
The bottom line is that refinancing isn’t always worth it. In some cases, you might not be able to qualify for a new mortgage with better terms.
As with anything else, refinancing has pros and cons that you should consider.
We’ve already gone over the benefits of refinancing, but to recap, the primary advantages are:
Lower interest rates: By successfully reducing your interest rate, you could save several hundreds of dollars per month.
Shorter term: Refinancing can help you pay off your mortgage several years sooner than you expected.
Lower monthly payments: If you’re struggling to make your current payments, refinancing could be the solution.
All things considered, refinancing can help you save a lot of money and pay off your mortgage more quickly.
Refinancing can be great, but it does have its disadvantages.
Prepayment penalties: Some mortgage providers charge prepayment penalties. Meaning, by refinancing, you might incur several thousands of dollars in fees.
You might not qualify: Refinancing is only worth it if you’re able to qualify for the benefits you’re after. If you don’t qualify for these benefits, this will just be a waste of time.
Additional expenses: When applying for a new mortgage, you might have to pay some additional closing costs, such as application fees, origination fees, etc. Refinancing can be a more expensive process than you are prepared for.
With these factors in mind, it’s up to you to decide whether or not refinancing is worthwhile. If you can find the right mortgage, refinancing can save you thousands of dollars over time.
How to Refinance
If you’ve decided to refinance, it’s important to understand how the process works and how you can find the best new mortgage for your needs.
Understand Your Credit Score
Your credit score makes a huge impact on your eligibility.
Low credit scores indicate high risk to lenders. As a result, a low credit score could prevent you from qualifying for a mortgage, increase your interest rates, or require you to pay mortgage insurance.
If your credit score hasn’t improved since you borrowed your original loan, then refinancing may not be a viable option.
Assess Your Home’s Value
It’s important to find out how much equity you have in your home. That is the difference between your home’s current value and how much you owe on your mortgage.
If you have at least 20% of your home’s value in equity, then you should have plenty of great options to pursue when refinancing.
Use a Calculator
A mortgage refinance calculator will help you compare your current mortgage with refinancing opportunities.
This tool will help you see whether or not your new mortgage will actually save you money and, if so, how much you will be saving.
Shop for Lenders
Finding the right lender is probably the most important step in the refinancing process. You need to find a lender that meets your needs and can offer the terms that you’re after.
Generally, the best way to find the perfect lender is to get quotes from multiple lenders and compare. Be sure to read reviews online and look for any additional fees and costs.
You should also consider getting pre-approved by multiple lenders. Pre-approval requires you to submit basic financial information, which lenders can use to put together a more accurate quote.
Apply for a New Mortgage
Refinancing involves applying for a new mortgage. You’ll need pretty much the same information that you use to apply for any other type of loan, including:
Proof of employment
This information will help lenders get a better idea of your current financial situation so that they can create an offer.
If your application is approved and you are happy with the terms, the last step is to lock in your interest rate and close.
With mortgages, you have to lock in the interest rate in order to ensure it doesn’t increase by the time you close the deal. When you lock in your rate, it will remain unchanged for a predetermined amount of time — giving you time to consider the offer before closing.
After closing, you are typically given a three-day period to reconsider the agreement. During this period, you can back out of the agreement for any reason.
Once this period has passed, your new mortgage will be disbursed to pay off your previous loan.
Frequently Asked Questions
- Can I refinance with bad credit?
Unfortunately, the answer is likely no. Refinancing is typically done to secure lower interest rates and new terms. With poor credit, you likely won’t qualify for better terms.
- How much equity do I need?
As mentioned previously, 20% is a good benchmark to aim for as many lenders require at least that much. However, this could be as low as 3%, if refinancing to an FHA loan.
- Can I change lenders?
Yes, there is no reason to stay with your current lender if you are unhappy with them. However, it might be helpful to stay with your current lender as you might benefit from being an existing customer.
- Are there closing costs?
Refinancing will require you to pay additional closing costs. This can be anywhere from two to five percent of the mortgage. If you can’t afford these costs, lenders may waive them in exchange for increasing your interest rate.
Based on a 30-Year Fixed rate mortgage monthly payment for a $200,000 loan at 4%