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What Is Mortgage Refinance?
When interest rates on home loans drop, mortgage refinancing becomes a hot topic for homeowners. After all, a lower interest rate could result in significant savings over the life of the loan. In fact, mortgage refinancing offers many benefits that could be a good financial move for you.
For instance, many homeowners look to replace their existing mortgage with a new mortgage loan in order to reduce their monthly payment or receive much-needed cash for large expenses.
Of course, there can be some downsides to mortgage refinancing as well, so it’s important to carefully evaluate the terms of a refinancing offer to see if it’s the right choice for you.
What is a mortgage refinance?
What is refinancing? In a nutshell, a mortgage refinance means replacing your existing mortgage loan with a new mortgage loan with a different rate or terms. However, refinancing a mortgage is not the same for everyone because different homeowners use refis for different purposes.
Reasons for mortgage refinancing include:
- Lowering your monthly payment. When refinancing, you can receive a lower interest rate or change the loan term to reduce your monthly mortgage payment.
- Change the type of mortgage you currently have. For instance, you may change from an adjustable-rate mortgage to a fixed-rate mortgage to avoid paying higher interest rates during the adjustable rate phase. Or, you may convert a Federal Housing Administration (FHA) loan to a traditional mortgage loan so you no longer have to adhere to certain FHA loan requirements.
- Shorten the loan term. If you’re in good financial shape, you can refinance your mortgage to receive a higher monthly payment to pay off your loan faster.
- Get much-needed cash. If you have equity in your home, you can refinance for more than you owe on your current mortgage and take the extra cash out to pay for significant expenses, like home improvements, high-interest debts or your child’s college tuition.
How a mortgage refinance could lower your current mortgage rate
Mortgage refinancing always makes headlines when mortgage interest rates go down. However, that does not mean every homeowner should run out and refinance their mortgage. The difference between the new rates and your current rate, along with your individual mortgage refinance terms, should be what determines if refinancing is actually right for you.
[ Related: When Should You Refinance Your Mortgage? ]
It’s important to look at the new interest rates compared to your existing rate to see how much it could save you. You then need to compare this to how much you will pay in closing costs on the loan to see if you are saving more than you pay to refinance.
You may be able to get a good rate and reduced closing costs by obtaining a streamlined refinance. With a streamline refinance, mortgage lenders forego their usual mortgage requirements so you don’t have to pay for things like a home appraisal, which could reduce your closing costs.
What are closing costs?
Every mortgage loan includes closing costs, which pay for processing the loan. You paid these costs with your existing mortgage, and you’ll pay many of the same fees and expenses when refinancing a mortgage. These include loan underwriting fees, appraisal fees, attorneys fees, title search and insurance fees, notary fees, recording fees and others. According to the Federal Reserve, closing costs commonly range between 3% and 6% of the loan principal.
In most cases, closing costs are paid when you close on the refinanced mortgage loan. Therefore, it’s important to find out the total amount early on in the loan process to make sure you have the funds available and that they make sense. Some mortgage lenders offer a “no closing costs” option, which rolls the closing costs into your total loan balance. The downside is that you either end up paying interest on these costs or the lender charges you a higher interest rate to cover the lost closing costs.
How to refinance your mortgage
If you want to refinance your mortgage, the first step should be to shop around and find the best rates and terms for you. When talking with different lenders, ask them about getting preapproved. They will look at your income, assets, debt and credit score to determine how much you can borrow for your mortgage refinance. This helps determine if refinancing is the right financial move for you.
[ Read: The Guide to Refinancing Your Mortgage ]
After you choose a lender and agree on the interest rate, lock in the interest rate to make sure it doesn’t increase before you close on the mortgage refinance. The mortgage lender will process the refinance and prepare all of the closing documents on the loan at that time. Once the closing documents are ready, you will sign them and pay your closing costs to finalize the mortgage refinance.
Tips for refinancing
Before refinancing your mortgage, decide what the purpose of a mortgage refinance would be for you. Do you want to reduce your monthly payment? Change the terms? Get cash? The answer will help determine how to find the right mortgage refinance for you.
You also should shop around with different lenders. Start with your current lender, as they will be motivated to keep your business. They may offer better rates or waive certain closing costs to make that happen. But make sure to also talk with other lenders to see if you may find a more favorable deal.
You should also have your financial documents ready for your lender. These include paycheck stubs, bank statements and tax returns. This can help speed up the refinancing process.
If you have bad credit but want to refinance, consider boosting your credit score before applying for a mortgage refinance. You can do this by making on-time payments to creditors, paying down debt and checking your credit score for errors.
If your lender requires another appraisal, make sure your home looks great for the appraiser. Don’t just clean inside — make everything look nice and tidy. Mow the grass, clean up the flower beds, and make sure the porches and patios look good.