- First, decide if mortgage refinancing is right for you
- If you decide to refinance, prepare for the process
- Shop around for the best rates across multiple lenders
- Compare fees and closing costs
- Get your paperwork together
Buying a house can be a great way to build wealth. After all, as your equity increases so does your net worth. You may be able to improve your financial situation even more if you refinance your home, but how do you refinance your mortgage?
First, let’s talk basics —
What is a mortgage refinance?
Refinancing a mortgage is the process of taking out a new mortgage loan and paying off the existing one.
A mortgage refinance can save you tens of thousands of dollars.
However, if you don’t understand the process, refinancing could cause you to spend more money over the life of the loan.
Reasons for refinancing a home
Knowing when to refinance is just as important as knowing how. There are a number of reasons that people choose to refinance a mortgage.
- To get a lower interest rate: In the last couple of years, interest rates have been historically low, though they are now beginning to rise. If you purchased a home when interest rates were two to three percentage points higher than current rates, you can save a significant amount of money on interest by refinancing.
- To get a lower mortgage payment: If you refinance your mortgage loan to get a lower interest rate, you will often come away with a lower monthly payment, which can free up money for other living expenses.
- To change the length of the loan: If you are dreaming about the day when your home will be paid off, you can reach that goal much faster if you refinance to change the length of the loan. If you refinance your mortgage and get a lower interest rate, you may be able to switch from a 30-year mortgage to a 15-year mortgage with little change to your existing mortgage payment. Not only would you pay off your mortgage faster, but you would save money in interest over the life of the loan.
- To take cash out: If you have equity in your home, you can take some of it out if you do a cash-out refinance. Your new mortgage would be larger than your previous one, and you would receive the difference in cash. Many people refinance their homes to get cash for home improvements, pay for a child’s college education, or consolidate debt.
- To replace an adjustable-rate mortgage with a fixed-rate loan: There are two primary types of mortgages. With an adjustable-rate mortgage, you’ll start out with a lower interest rate than if you took out a fixed-rate loan. But if interest rates go up or down, so will your monthly payment. Since there’s no predicting what will happen with interest rates over the life of your loan, it’s impossible to know exactly what your monthly payment and total repayment costs will be by the time you’re done repaying your mortgage. A fixed-rate loan offers more certainty. Although you’ll start out with a higher rate than you would with a variable-rate loan, your mortgage payment will stay the same for the life of the loan. With interest rates currently on the upswing, it might make sense to do a mortgage refinance to lock down a fixed-rate loan with a stable payment.
- To get out of paying FHA or VA mortgage insurance premiums: If you purchased your home with FHA or VA mortgage insurance, once you have 20 percent equity in your home, you can refinance into a conventional loan and avoid paying costly insurance premiums.
You can refinance your mortgage at any time, though some lenders have guidelines about how soon they will refinance an existing loan.
For example, your lender may require you to wait a certain number of months before refinancing the loan on a home that you recently bought. Still, you can likely find another lender willing to refinance your loan immediately if you qualify.
While there is no limit to the number of times that you can refinance your mortgage, it is important to weigh both the pros and the cons.
Potential downsides of a mortgage refinance
Now that you understand the valuable benefits of refinancing a mortgage, let’s look at some of the potential downsides.
- Refinancing a mortgage is not cheap. In fact, closing costs can easily add up to as much as 5% or 6% of the loan. That means if you have a $200,000 mortgage, it’s not out of the question to have to fork over as much as $12,000. Closing costs include a number of underwriting and processing fees, such as the application fee, appraisal, lender fees, title fees, escrow fees and insurance and taxes.
- When determining whether you should refinance, it’s important to think about how long you plan to stay in your house. If you plan to sell the house in the near future, make sure that you’ll save enough in interest in that period of time to justify the upfront costs you incurred to refinance the loan.
- Extending the length of your mortgage is another potential downside. If you refinance your mortgage for another 30-year term, you’re adding years to your mortgage, which could cost you more in interest over time. If you don’t plan to sell your house and you’ve owned your house for 10 years and refinance to another 30-year term, you’d effectively be taking 40 years to pay off your house, which isn’t a great financial move.
- It’s also important to weigh the pros and cons before doing a cash-out refinance. Your equity is valuable, so think about what you are spending it on. Some people cash in on their equity to pay down high-interest credit card debt. While that can be a smart move if you are replacing high-interest debt with a low-interest mortgage, make sure you don’t end up running those credit cards back up again.
Step by step guide to refinancing your home loan
If you decide that refinancing is the best move for you, here’s how to refinance your mortgage:
Step One: Prepare for the process
When it comes to qualifying for a mortgage refinance, the same general rules apply as when you first bought your home. Lenders will look at your credit score, your income and the market value of your home. It will also be helpful to research your home’s current value by comparing it with similar homes in your neighborhood.
Step Two: Shop around for the best deal
It’s a good idea to shop around and see what other lenders will offer you. For example, one lender may offer you a lower rate while another may be willing to waive some of the closing costs, such as the application fee. Different lenders also have different credit score requirements.
Some lenders may give you the option of paying mortgage points. When you pay points, you spend more on fees when you close on your loan to get a lower interest rate. This might be a good strategy if you plan to keep the house for many years and can afford to pay for the points upfront.
Step Three: Compare fees and closing costs
When comparing lenders, in addition to evaluating interest rates, make sure you compare all of the fees and closing costs you will be expected to pay by comparing the Loan Estimates you are entitled to receive from the lenders.
Step Four: Gather your paperwork
Once you choose a lender, you will have to gather paperwork, such as pay stubs and bank statements, to give the underwriter so that they can approve and process your loan. You may also have to show proof that you don’t have any outstanding obligations related to your current mortgages such as unpaid property taxes or homeowners association dues.
Once your mortgage refinance is complete, you’ll have a new monthly payment and a fresh start on your home loan. If you considered your options and refinanced for the right reasons, it could be one of the best financial decisions of your life.