Mortgage rates are still at lows, giving homeowners who haven’t already taken advantage of lower borrowing costs an extended opportunity to refinance. The mortgage refinancing process isn’t much different from what was involved when you first got your mortgage, but understanding how it works and the options available to you can help you make a more informed decision and get the best rate.
WHAT IS REFINANCING?
Mortgage refinancing entails replacing your current mortgage with a new loan, ideally at a lower interest rate. Refinancing can allow you to lower your monthly payment, save money on interest over the life of your loan, pay your mortgage off sooner and draw from your home’s equity if you need cash for any purpose.
HOW DOES REFINANCING A MORTGAGE WORK?
When you refinance, your new loan will have a different interest rate and terms, and could be from a different lender than the one you originally worked with.
With this new loan, you might be resetting the repayment clock. Say you’ve made five years of payments on your current 30-year mortgage. That means you have 25 years left on the loan. If you refinance to a new 30-year loan, you’ll start over and have 30 years again to repay it. If you refinance to a new 20-year loan instead, you’ll pay your loan off five years earlier.
Refinancing comes with closing costs, which can affect whether getting a new mortgage makes financial sense for you. These costs can be between 2 percent and 5 percent of the amount you refinance. Common closing costs include discount points, an origination fee and an appraisal fee.
COMMON REASONS TO REFINANCE A MORTGAGE
There are many good reasons to pursue a refinance, the biggest of which is lowering your interest rate. If you can reduce your rate by one-half to three-quarters of a percentage point or more, refinancing is likely worth it, as long as you plan to stay in the home long enough to recoup the closing costs. Town & Country's mortgage refinance calculator can help you decide.
“You may be able to reduce your interest rate and monthly mortgage payments,” notes Alan Rosenbaum, CEO and founder of New York City-based GuardHill Financial Corp. “Also, if you’ve built up equity in your home, you can take out cash at closing to pay for home improvements, consolidate debt, invest or pay for a large transaction.”
You can also refinance to shorten your loan term and pay it off faster, resulting in less interest paid over the life of your loan. One option is refinancing a 30-year mortgage into a 15-year one.
If you have an adjustable-rate mortgage, refinancing to a fixed-rate loan can be a smart move, too. You’ll have peace of mind knowing that your principal and interest payments will stay the same throughout the loan term.
In addition, if you’ve been paying for private mortgage insurance, refinancing can eliminate those payments if you’ve reached at least 20 percent equity in your home.
“The best candidates for refinancing are homeowners who have a high interest rate on their current loan, have a strong equity position or have a need for cash to fund other family expenses or plans,” says Guy Silas, branch manager at Embrace Home Loans, headquartered in Middletown, Rhode Island.
PROS AND CONS OF REFINANCING A MORTGAGE
- Lower your interest rate
- Lower your mortgage payment
- Decrease the term of your loan and pay it off sooner
- Tap into your home’s equity and take cash out at closing
- Consolidate debt
- Change from an adjustable-rate to a fixed-rate mortgage, or vice versa
- Cancel mortgage insurance premiums
- Expensive closing costs
- Potential for a longer loan term, adding to your costs
- Less equity in your home if you take cash out
- Borrower’s remorse if rates drop substantially after you close
- Refinancing process can take between 15 and 45 days or more
TYPES OF MORTGAGE REFINANCING
There are a few types of mortgage refinancing options to choose from:
- Traditional rate-and-term refinances change either the interest rate of the loan, the term 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.
- Cash-out refinances let you take some of the equity in your home and turn it into cash you can 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.
- Debt-consolidation refinances are like cash-out refinances, except you use the cash from the equity you’ve built to repay other non-mortgage debt, like credit card debt. Your mortgage debt will increase, but because mortgage rates are usually lower than other loan rates, this can save you money in the long run.
- Streamline refinances accelerate 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 and Fannie Mae and Freddie Mac loans.
HOW TO REFINANCE A MORTGAGE
1. DO THE MATH AND PREPARE
Before you refinance your mortgage, it’s important to be sure that refinancing is a financially sound move based on your situation. Before you start applying for offers:
- Check your credit to make sure you can qualify for a new loan.
- Make sure you have enough equity in your home — usually at least 20 percent.
- Check current interest rates to see what’s available.
- Make sure you can fit the new payment in your monthly budget.
2. SHOP AROUND FOR MORTGAGE LENDERS
You don’t have to refinance with the same mortgage lender you got your first mortgage from, and shopping around for a loan is one of the best ways to make sure you get a good deal. Take the time to compare offers from a few different mortgage refinance lenders. This could mean going through the preapproval process a few times, but the good news is, if multiple lenders check your credit within a short period of time, your score won’t reflect the multiple inquiries.
3. COMPARE RATE QUOTES AND LOAN TERMS
Once you’ve narrowed down refinance offers, evaluate them carefully. The interest rate is of course a major consideration, but also take the time to review the closing costs and other loan terms. If one of the offers includes an early repayment fee, for example, that means paying more if you decide to refinance again sometime in the future.
Once you’ve settled on an offer, it’s time to complete a mortgage application and supply the necessary documents, including pay stubs, tax returns and bank statements. When you actually apply for a refinance (as opposed to getting a preapproval or prequalification), the lender is going to take a very close look at your credit and financial situation. You might be asked for more information as the lender scrutinizes your application, too, so it’s important to be prepared to answer these questions quickly to keep the process on track.
5. LOCK IN YOUR INTEREST RATE
Once you’re approved for your refinance, most mortgage lenders allow you to lock in your interest rate. With a locked rate, even if market rates rise before you close on the loan, your rate will stay the same. (However, your rate won’t decrease if market rates fall.) When you lock in your rate, you can start planning your monthly budget because you’ll have a good sense of how much your payments will be.
6. HAVE YOUR HOME APPRAISED
Your mortgage lender will order an appraisal of your home to make sure it’s worth enough to secure the new mortgage. You’ll generally have to pay for the appraisal as part of your closing costs, but some lenders waive this fee for existing clients or for other reasons, so be sure to ask if this is an option.
7. CLOSE ON THE LOAN
On closing day, make sure to bring any documents your lender requires and be ready to pay closing costs (usually with a certified or cashier’s check), unless you’re rolling them into the loan.
DOES REFINANCING AFFECT MY CREDIT?
Refinancing a mortgage can also have some impact on your credit, but it’s usually minimal. This can occur for multiple reasons:
- Mortgage lenders conduct a credit check to see if you qualify for a refinance, and this appears on your credit report. A single inquiry can shave up to five points off your score. “When you apply for a mortgage refinance, it triggers a hard credit inquiry that may lower your credit score by only a few points, but this will be temporary,” explains Matt Hackett, operations manager at Equity Now, a direct mortgage lender in New York City.
- If you plan to apply for other types of debt, such as a car loan or credit card, in addition to refinancing, your credit score can also be affected.
- When you refinance, you’re closing one loan and opening another. Your credit history makes up 15 percent of your score, so having one loan close and then taking on a new one shortens the duration, impacting your score.
In general, these effects will only be felt for a short period of time. If you’re concerned about hurting your score while you compare refinance offers, try to shop for loans within a 45-day window. Any credit pulls related to your refinance in this timeframe will only be counted as one inquiry.
With additional reporting by TJ Porter and Dhara Singh
Originally published by Erik J. Martin for Bankrate.com.
Erik J. Martin for BankRate and republished by HerMoney.com.