Mortgage Refinance
A mortgage refinance is when you replace your current mortgage with a new mortgage that has a different interest rate or to borrow more money. Getting a lower rate and saving money on interest payments over the life of the loan are two benefits of refinancing your home. But they aren’t the only ones! Call Today!
What is mortgage refinance?
Mortgage refinance essentially allows you to tap equity or save your money by replacing your home loan with a new one. The reason homeowners usually refinance is to cut monthly payments, reduce their interest rate, or access the equity of their home. Other common reasons to refinance your mortgage would be to eliminate Federal Housing Administration (FHA) mortgage insurance, switch to a fixed-rate loan from an adjustable-rate loan, or simply to pay off your loan more quickly.
Since your mortgage will likely be one of the largest investments of your life, it is important to understand the best options for you when thinking about the best loan for purchasing your home for a second time.
How Mortgage Refinancing Works
In general, here’s a step-by-step overview of the mortgage refinancing process:
- Loan evaluation and goal establishment. A few different reasons a homeowner may want to refinance are mortgage interest rate reductions, switching to another type of mortgage, or home renovations. For homeowners, the first step in the refinance process is to evaluate the current mortgage loan and identify their financial goals before moving forward.
- Find the best lender. Once borrowers identify their goals, they’ll search for lenders that can offer them the right mortgage for their situation. Prospective refinancers may apply for multiple loans with different mortgage lenders and then compare the estimates using an online mortgage calculator to determine an ideal break-even point.
- Close on the loan. After the borrower finds the lender with the best loan terms for their needs, they will close on the new loan, sign documents, and pay any necessary closing costs.
- Pay off the original mortgage. With the money from the new refinance loan, the borrower will pay off their original mortgage. If they applied for a new loan that is larger than their initial loan, they keep the difference and use it to achieve their goals.
How to refinance your mortgage
Step 1: Set a clear financial goal
There should be a good reason why you’re refinancing — whether it’s to reduce your monthly payment, shorten the term of your loan or pull out equity for home repairs or debt repayment.
What to consider: If you’re reducing your interest rate but restarting the clock on a 30-year mortgage, you may pay less every month, but you will pay more over the life of your loan. That’s because most of your interest charges occur in the early years of a mortgage.
Step 2: Check your credit score and history
You’ll need to qualify for a refinance just as you needed to get approval for your original home loan. The higher your credit score, the better refinance rates lenders will offer you — and the better your chances of underwriters approving your loan. For a conventional refinance you will need a credit score of 620 or higher to be approved; in some cases, lenders will accept 580 for an FHA or VA refi mortgage. They won’t let you borrow as much, though.
What to consider: While there are ways to refinance your mortgage with bad credit, spend a few months boosting your score, if you can, before you start the process.
Step 3: Determine how much home equity you have
Your home equity is the total value of your home minus what you owe on your mortgage. To figure it out, check your mortgage statement to see your current balance. Then, check online home search sites or get a real estate agent to estimate your home’s current fair market value. Your home equity is the difference between the two. For example, if you still owe $250,000 on your home, and it is worth $325,000, your home equity is $75,000.
What to consider: You may be able to refinance a conventional loan with as little as a 5 percent equity sake, but you’ll get better rates and fewer fees (and won’t have to pay for private mortgage insurance or PMI) if you have at least 20 percent equity. The more equity you have in your home, the less risky the loan is to the lender.
Step 4: Shop multiple mortgage lenders
Getting quotes from at least three mortgage lenders can save you thousands. Once you’ve chosen a lender, discuss when it’s best to lock in your rate so you won’t have to worry about rates climbing before your loan closes.
What to consider: In addition to comparing interest rates, pay attention to the various loan fees and whether they’ll be due upfront or rolled into your new mortgage. Lenders sometimes offer no-closing-cost refinances but charge a higher interest rate or add to the loan balance to compensate.
Bankrate’s refinance rate table allows you to comparison-shop loans, to help you find the best fit for your financial needs.
Step 5: Get your paperwork in order
Gather recent pay stubs, federal tax returns, bank/brokerage statements and anything else your mortgage lender requests. Your lender will also look at your credit and net worth, so disclose all your assets and liabilities upfront.
What to consider: Having your documentation ready before starting the refinancing process can make it go more smoothly and often more quickly.
Step 6: Prepare for the home appraisal
Mortgage lenders typically require a home appraisal (similar to the one done when you bought your house) to determine its current market value. An outside appraiser will evaluate your home based on specific criteria and comparisons to the value of similar homes recently sold in your neighborhood.
What to consider: You’ll pay a few hundred dollars for the appraisal. Letting the lender or appraiser know of any improvements, additions or major repairs you’ve made since purchasing your home could lead to a higher appraisal.
Step 7: Come to the closing with cash, if needed
The closing disclosure, as well as the loan estimate, will list how the extra expense in closing costs to finalize the loan. You may need to pay 3 to 5 percent of your total loan at closing.
What to consider: You might be able to finance the costs, which can amount to a few thousand dollars, amortizing them over the course of your loan. But you will likely pay more for it through a higher interest rate or total loan amount, which amounts to more interest in the long run. (And yes, they’ll probably slap you with a fee to do it, too.) It often makes more financial sense to pay upfront if you can afford to.
Step 8: Keep tabs on your loan
Store copies of your closing paperwork in a safe location and set up automatic payments to make sure you stay current on your mortgage. Some banks will also give you a lower rate if you sign up for autopay.
What to consider: Your lender or servicer might resell your loan on the secondary market either immediately after closing or years later. That means you’ll owe mortgage payments to a different company, so keep an eye out for mail notifying you of such changes. The terms themselves shouldn’t change, though.
Reasons you should refinance your home loan
When the costs of refinancing can be recouped in a reasonable period, it might make financial sense to do, depending on your goals. These could include:
- To reduce your monthly mortgage payment. Securing a lower interest rate can lower your mortgage payments by hundreds of dollars.
- To pay your mortgage off sooner. If you convert a 30-year mortgage into a 15-year one, you can pay it off faster and reduce the total amount of interest you owe.
- To make your mortgage payment more manageable. Taking out a 30-year mortgage to replace a 15-year mortgage can help reduce your monthly payment.
- To switch from an adjustable-rate mortgage (ARM) to a fixed-rate loan. This is smart if you think rates will go up in the future or if you just want a predictable monthly payment
- To take advantage of your home equity. After you pay off your original mortgage, any money left over can be earmarked for home renovation projects, debt consolidation or paying large expenses, like college tuition bills.
- To eliminate mortgage insurance. This applies mainly to FHA loans that financed more than 90 percent of the original home purchase. Their mortgage insurance premiums can only be canceled if you refinance the loan, swapping it out for a new non-FHA one. However, the new lender will have wanted you to have built up at least 20 percent equity in your home.
- A refinance calculator can crunch the numbers and determine how much you can afford to refinance.
Benefits of refinancing your mortgage
- Free up money each month — If interest rates have fallen since you first got your mortgage, a rate-and-term refinance can replace your loan with a new one that has a lower rate, meaning you pay less to your lender each month.
- Pay your home off faster — If you got your mortgage some time ago and never refinanced, refinancing to a new loan with a shorter term and a lower interest rate could substantially reduce interest payments. One word of caution: if you’re putting more cash into paying off your mortgage each month, you could have less money on hand for expenses or savings.
- Eliminate mortgage insurance — If rising home values and loan payments have pushed your home equity above 20 percent, you might be able to refinance into a new conventional loan without private mortgage insurance (PMI). (Depending on your loan terms, your lender could remove PMI as soon as you meet the 20 percent equity threshold without needing to refinance.)
- Change your FHA loan into a non-FHA loan — If you have an FHA loan and put down less than 10 percent, the only way to remove the mortgage insurance is by refinancing to a non-FHA loan. Even with today’s higher interest rates, this move could save you money overall.
- Tap your home’s equity — If you have over 20 percent equity in your home, you could turn to cash-out refinancing. By refinancing your home loan into a new mortgage for a more significant amount, you could receive the difference in ready money to spend however you like. Cash-out refinancing makes sense if you use the money to invest back into your home through a major remodeling project or pay off high-interest debt.
- Lock in a fixed-rate mortgage — If you’re in an adjustable-rate mortgage (ARM) that’s about to reset and you believe interest rates will rise, you can refinance into a fixed-rate loan. Your new rate might be higher than what you’re paying now, but you’re guaranteed it won’t rise in the future.
Considerations before refinancing your mortgage
- Refinancing isn’t free — Just like your original mortgage, your refinanced mortgage comes with costs, such as an origination fee, an appraisal, title insurance, taxes and other fees. You only save money until the monthly savings offset the cost of refinancing. You’ll need to do some math (use this calculator) to figure out how many months it will take to reach this break-even point. If there’s a chance you’re going to move before then, refinancing is probably not the best move.
- You might have a prepayment penalty — Some mortgage lenders charge you extra for paying off your loan early. A high prepayment penalty could tip the balance in favor of sticking with your original mortgage.
- Your total financing costs can increase — If you refinance to a new 30-year mortgage and you’re well into paying off your initial 30-year loan, you’re going to pay more in interest than if you’d kept the original mortgage since you’re extending the loan repayment time.
Types of mortgage refinancing
There are many refinance options available for mortgage products, so you will want to evaluate the types of refinance available to you and consider each within the context of your unique financial situation. Your goal may be to adopt a shorter loan term, or maybe your focus is lower monthly payments. Explore the options available to decide which type of refinance best suits your objectives.
This is a basic form of refinancing that changes either the interest rate of the loan, the term (repayment length) of the loan or both. This can reduce your monthly payment or help you save money on interest. The amount you owe generally won’t change unless you roll some closing costs into the new loan.
When you do a cash-out refinance, you’re using your home to take cash out to spend. This increases your mortgage debt but gives you money that you can invest or use to fund a goal, like a home improvement project. You can also secure a new term and interest rate during a cash-out refinance.
With a cash-in refinance, you make a lump sum payment in order to reduce your loan-to-value (LTV) ratio, which cuts your overall debt burden, potentially lowers your monthly payment and also could help you qualify for a lower interest rate. Before making a cash-in refinance, you’ll want to evaluate whether paying the lump sum would deprive you of more lucrative opportunities or needlessly drain your savings.
A no-closing-cost refinance allows you to refinance without paying closing costs upfront; instead, you roll those expenses into the loan, which will mean a higher monthly payment and likely a higher interest rate. A no-closing-cost refinance makes most sense if you plan to stay in the home short-term.
If you’re struggling to make your mortgage payments and are at risk of foreclosure, your lender might offer you a new loan lower than the original amount borrowed and forgive the difference. While a short refinance spares the borrower the financial impacts of a foreclosure, this option comes at the expense of a hit to your credit score.
If you’re a homeowner aged 62 or older, you might be eligible for a reverse mortgage that allows you to withdraw your home’s equity and receive monthly payments from your lender. You can use these funds as retirement income, to pay medical bills or for any other goal. You won’t need to repay the lender until you leave the home, and while the income is tax-free, it’ll accrue interest.
Similar to cash-out refinances, debt consolidation refinances give you cash with one key difference: You use the cash from the equity you’ve built in your home to repay other non-mortgage debt, like credit card balances. Your mortgage debt will increase, but you will be able to pay other debts down or off entirely. Plus, you might be able to take advantage of the mortgage interest deduction.
A streamline refinance accelerates the process for borrowers by eliminating some of the requirements of a typical refinance, such as a credit check or appraisal. This option is available for FHA, VA, USDA and Fannie Mae and Freddie Mac loans.
How Much Do I Pay to Refinance?
Mortgage refinancing isn’t free. You’ll pay several fees to your new lender, and other professionals as well to compensate them for processing the loan. Some of the costs of refinancing include:
- Application fees: This expense covers the cost to process your loan and perform credit checks.
- Origination fees: This is a one-time fee that you pay for loan preparation.
- Appraisal fees: This covers the cost of an appraisal to assess the value of your home.
- Inspection fees: You’ll be charged this fee if your home requires an inspection to assess its condition before being approved for a new mortgage.
- Closing costs: This includes fees for the attorney who handles the closing of the loan on behalf of the lender.
Altogether, refinancing fees can amount to 3% to 6% of the remaining principal on the mortgage. Your lender might not require that you pay these fees upfront if you qualify for a “no-cost refinancing,” but you’ll still effectively pay them through a higher interest rate throughout the loan.
Which Type Of Mortgage Refinance Loan Is Right For You?
When deciding among the different types of refinancing options, there are several factors you ought to take into consideration, including:
- The type of mortgage loan you have
- The type of borrower you are (for example, a veteran with a VA loan)
- The goals you hope to achieve by refinancing
- The amount of equity you have in your home
- Your credit score
- Your DTI ratio
- Your LTV ratio
- Your overall financial standing (your ability to afford closing costs, your ability to pay off additional debt, etc.)
If you’re still unsure as to which type of refinance would best fit your needs, talk to your lender about what potential terms for different refinances would look like and to get other mortgage refinance tips.
How Do I Qualify for Refinancing?
Qualifying for a refinance is the same as qualifying for a purchase home loan, as lenders want to make sure you can afford the payments and that you will make them on time per your contract. Although each lender has different requirements, generally all lenders will look at your credit score, debt-to-income ratio (DTI), income and home equity.
For conventional mortgages, a credit score between 620 and 720 is preferred. The credit score minimum might also depend on your cash reserves, DTI and the loan-to-value ratio. Also, lenders usually reward high credit scores with the lowest available interest rates.
FHA loans have lower minimums than conventional mortgage refinances, but some lenders might apply a credit overlay, which means they will raise the minimum score to offset risk:
- 500 if your new loan has an LTV of 90% or less
- 580 if your new loan has an LTV of over 90%
There is no credit check for an FHA streamline refinance. There are also no credit score minimums for USDA or VA refinances; however, lenders might apply their own standards to these refinances.
When Is Refinancing Worth It?
There are many scenarios where refinancing makes sense. In general, refinancing is worth it if you can save money or if you need to access equity for emergencies.
Borrowers with FHA loans must refinance into a conventional loan in order to get rid of their mortgage insurance premium, which can save hundreds or thousands of dollars per year.
Some borrowers refinance because they have an adjustable-rate mortgage and they want to lock in a fixed rate. But there are also situations when it makes sense to go from a fixed-rate to an adjustable-rate mortgage or from one ARM to another: Namely, if you plan to sell in a few years and you’re comfortable with the risk of taking on a higher rate should you end up staying in your current home longer than planned.
What documents do I need to refinance my mortgage?
To refinance your mortgage, you’ll need to supply identification, income verification and credit information. Be sure to ask your lender for a list of documents you’ll need. The faster you can give the lender everything they need to process your loan, the quicker you’ll be able to close.
Here’s a general checklist:
- W-2s or 1099s
- Recent pay stubs
- Most recent tax returns
- Statement of assets
- Statement of debts
- Proof of property insurance
- Appraisal
Find the Best Rates For Refinancing Your Mortgage
The costs of refinancing a mortgage can add up quickly, so it’s important to research which lenders offer the most competitive interest rates and fees. To find the best refinancing terms, start by looking at your current lender. Likewise, if you already have a relationship with another bank, it can likely streamline the application process and provide more favorable terms.
If you’re getting a conventional mortgage, nationally chartered or community banks are usually the best places to start. Shop around at a variety of large banks, local banks and credit unions to ensure you get the best terms for your needs and credit history. Also keep in mind that if you want to refinance quickly, you may want to consider an alternative lender, like an online non-bank company—although this generally comes with a higher interest rate.
To get the best refinancing rates, pay attention to these factors before applying:
- Credit score. Your credit score is an important part of how lenders calculate loan eligibility and, ultimately, interest rates. For example, in June 2020, myFICO, a division of the company that produces the most widely used credit scores, reported that borrowers with a credit score between 760 and 850 could expect around a 2.9% APR on a 30-year $300,000 mortgage; in contrast, a score between 660 and 679 might have earned an interest rate closer to 3.5%.
- Home equity. A borrower’s loan-to-value ratio—the amount owed on the current mortgage loan divided by the home’s current value—is also an important factor during the refinancing process. You should have at least 5% equity in your home before refinancing, but this number varies depending on the type of mortgage. If you have less than 20% equity in your home, expect to pay mortgage insurance.
- Availability of cash to lower your interest rate. Paying points—a lump-sum fee paid to the lender at closing—allows you to earn a lower interest rate on your new loan. Plus, your lender may be willing to negotiate an interest rate reduction larger than the standard 0.25% per point.
- Employment status. Before refinancing a mortgage, lenders want to know you can make the monthly payments. Compile employment documents like recent W-2s and tax returns before applying for a new loan—especially if you’re self-employed or recently switched jobs.
- Debt-to-income ratio. Ideally, your new mortgage payment should be less than 30% of your monthly income; total household debt should be less than 40% of your monthly income.
Start Your Refinance Today
Whether you’re looking to lower your payment, consolidate debt, or get cash out, refinancing your current mortgage could be easier than you think. Call Today!