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How to Refinance Your Mortgage
Refinancing your mortgage may help you cash in on interest rate savings, lower monthly payments and even get you access to your home’s equity. Before you move forward with a refi, though, you need to know what situations a refinance is ideal for.
Mortgage interest rates are extremely low right now, so the talk of the town among homeowners is refinancing. While homeowners are right that refinancing brings a lot of benefits to the table, it also opens the door for questions, too. Knowing when to refinance your mortgage and how to refinance your mortgage is a critical part of cashing in on benefits like lower payments, more favorable repayment terms and interest savings.
What is a mortgage refinance?
Mortgage refinancing is the blanket term that refers to taking out a new home loan to pay off your existing home loan. Once completed, you’re no longer bound by the terms of your original home loan. You get new terms and new rates with your new loan instead. This is often done to capitalize on a better interest rate or to lower the size of your monthly mortgage payments.
While traditional refinancing is fairly straightforward, there are other types of mortgage refinancing available, too. For example, a cash-out refinance allows you to tap into the equity you’ve built in your home in the form of a cash loan that can be used for large purchases or debt consolidation. You’re still paying off your old loan and replacing it with a new loan, but you’re getting a lump sum of cash in the process. The new loan amount will be higher than the old one, though, because you’ll have to pay back the equity you borrowed during the refi.
But what do you do if you don’t have a conventional loan? You may still be able to refinance, even if you opted for a more specialized loan type when you bought your home. For example, FHA loans can be refinanced through the FHA Streamline program. With this program, you can capitalize on the same benefits, but it requires less credit documentation, no appraisal and minimal underwriting. In other words, the process is much easier and faster than a traditional refinance.
No matter what type of mortgage refinance you’re doing, the bottom line is the same. You’re taking out a new loan to pay off your existing mortgage to take advantage of more favorable loan terms. What those terms are is up to your unique situation.
[Read: Tips for Getting a Mortgage]
Benefits of lower interest on a mortgage
One of the chief reasons to refinance your mortgage is to save with a lower interest rate. While you won’t realize the savings immediately, over time you’ll begin to capitalize on the lower cost of borrowing.
For example, let’s say that you have a $300,000 outstanding loan balance with a 5.5% annual interest rate and 25 years (300 months) left on your loan. Your current monthly payment is $1,842. If you have the option to refinance to a rate of 3.5%, you could save significantly. By refinancing to a new $300,000 loan with a 3.5% APR and 30 years (360 months), your payments would drop to $1,347 a month.
The savings would be about $495 a month. If you didn’t refinance, you’d pay $552,600 over the remainder of your loan. When you refinance with this example, you are adding five years onto your payments, but the total you’ll pay is still considerably less at $484,920.
The reason you won’t realize these savings immediately is because of closing costs. For example, if you had to pay $6,000 in closing costs on this deal, you be down $6,000 in the first month and only recouping $495 in savings.
However, as time goes on, the savings would chip away at the closing costs. When you hit the breakeven point, the savings would cover the closing costs and you’d start to reap the benefits of your refinance.
How to refinance your mortgage
There are several steps involved in refinancing your mortgage. Fortunately, none of them are overly complicated.
1. Study your most recent statement to determine how much you still owe on your mortgage.
2. Shop with different mortgage lenders. Ask them for their interest rates and fees, but be aware: A lender can’t tell you exactly what interest rate you’ll get if they don’t first look at your credit and financial health.
3. Ask lenders to run your numbers to determine how much money you might save each month. You should also ask them to estimate how much you’ll have to pay in closing costs to close a mortgage. Determine how long it will take your monthly savings to pay back your closing costs to make sure a refinance makes sense.
4. Once you’ve selected a lender, fill out that lender’s Uniform Residential Loan Application, the form that will officially start the refinance process. You’ll need to provide such information as your full name, address, employment, income and debt levels.
5. Gather copies of your most recent paycheck stubs, bank account statements, tax returns and W-2s. Your lender will need this information to determine if you can afford your new monthly payment.
6. Give your lender permission to check your credit. Your lender wants to make sure you have a history of making your loan payments on time.
7. Wait. Your lender will now underwrite your refinance loan. Underwriters will study your financial health, credit history and employment history to determine how likely you are to pay your new mortgage payments on time. If underwriters like what they see, your lender will approve your refinance request.
8. Close the loan. You’ll have to sign several documents to close your mortgage refinance. You’ll also have to pay any closing costs here. Usually, you have the choice to pay these costs upfront or roll them into your loan.
9. Once your loan is closed, start making your new monthly payments on your refinance.
Am I eligible for refinancing?
A question by those wondering how to refinance your mortgage is whether or not they’re eligible. The best way to answer this question is by better understanding the refi process. When you’re refinancing, you are going through what is effectively the same process you went through when you purchased your home. You will have to deal with a loan closing, closing costs and many of the same steps that came with the first loan.
What this means is that eligibility requirements will be relatively the same. The new lender will look at your credit history, credit score and your debt-to-income ratio. The lender may also look at the value of your home. If the value has decreased significantly you may owe more than the house is worth, which is something that could cause your refinance loan to be denied.
When preparing to refinance, you’ll first need to gather all of the same documents you needed when you purchased your home. You’ll also need to collect all of the documents from your first loan as well as proof of your on-time payments. The new lender will need to see all of this to assess the situation and determine your eligibility for refinancing.
How to use our mortgage refinance calculator
Before deciding on a refinance, it’s important to determine how much you might save each month. Our mortgage refinance calculator can help you determine this.
To determine your savings, enter your monthly mortgage payment, loan balance, years remaining on your loan, property value and the type of mortgage you are refinancing into. You’ll then have the option to determine which APR you expect to get with your loan.
Once you’ve input these figures, our refinance calculator will tell you how much you’ll save a month, how much you’ll save in interest payments for the life of your loan, what your new monthly payment will be and our advice on whether your refinance makes financial sense.
Should I refinance?
Determining whether you should refinance and when to refinance your mortgage can seem confusing. Luckily, it boils down to one thing — can you get a better rate, more favorable repayment terms and save money by refinancing? If you can, then you should consider a refinance.
There are a few other things to consider as well, though. Do you have the money to cover closing costs? Are you staying in your home long enough to realize the savings?
- If interest rates are lower or your financial situation has improved (better credit score), you should look into refinancing.
- If your home has decreased in value significantly, you shouldn’t look into refinancing.
- If you aren’t staying in your home long enough to realize the financial benefits, you shouldn’t refinance.
- If you need access to cash for a fiscally responsible purpose and have a lot of equity built up in your home, you may want to consider refinancing.
Ultimately, if you have the financial resources to make a refinance happen and you can save money by doing it, it’s a move worth considering. A good lender can always help you weigh the pros and cons of your unique situation before you move forward.