Last Updated on November 18, 2020
This page provides detailed information on how to refinance your home loans. Here you will learn what refinancing is, how refinancing works, types of refinancing, the benefits of refinancing, complete mortgage refinancing process for beginners, and all other important mortgage refinancing information that you might need. Keep for updates.
Table of Contents
What Is Refinancing?
Refinancing involves the process of reviewing and replacing the terms of an existing credit agreement, usually with respect to a loan or mortgage.
When a business or individual decides to refinance a credit obligation, they are effectively seeking to make favorable changes to their interest rate, payment schedule, and / or other terms set out in their contract. If approved, the borrower gets a new contract that replaces the original agreement.
Borrowers often choose to refinance when the terms of interest rates change significantly, causing potential savings on debt repayments under the new arrangement.
How Refinancing Works?
Consumers typically seek to refinance certain debts in order to obtain more favorable borrowing terms, often in response to changing economic conditions. The common goals of refinancing are to lower its fixed interest rate to reduce payments over the life of the loan, change the term of the loan, or move from a fixed rate mortgage to an adjustable rate mortgage (ARM) or vice versa.
Borrowers can also refinance because their credit profile has improved, due to changes in their long-term financial plans, or to pay off existing debts by consolidating them into one loan at a low cost.
The most common motivation for refinancing is the interest rate environment. As interest rates are cyclical, many consumers choose to refinance when rates fall. National monetary policy, the economic cycle, and market competition can be key factors that raise or lower interest rates for consumers and businesses.
These factors can influence interest rates across all types of credit products, including both non-revolving loans and revolving credit cards. In a rising-rate environment, debtors with variable-interest-rate products end up paying more in interest; the reverse is true in a falling-rate environment.
In order to refinance, a borrower must approach either their existing lender or a new one with the request and complete a new loan application. Refinancing subsequently involves re-evaluating an individual’s or a business’ credit terms and financial situation. Consumer loans typically considered for refinancing include mortgage loans, car loans, and student loans.
Businesses may also seek to refinance mortgage loans on commercial properties. Many business investors will evaluate their corporate balance sheets for business loans issued by creditors that could benefit from lower market rates or an improved credit profile.
Types of Refinancing
There exist several types of refinancing options. The type of loan that a borrower decides to get depends on the needs of the borrower. Some of these refinancing options include:
1. Rate-and-term refinancing
The most common type of refinancing. Rate-and-term refinancing occurs when the original loan is paid and replaced with a new loan agreement that requires lower interest payments.
2. Cash-out refinancing
Cash-out refinancing are common when the underlying asset used as collateral has increased in value. A transaction involves the withdrawal of value or equity in an asset in exchange for a higher loan amount and often a higher interest rate. In other words, when an asset increases in value on paper, you can access that value through a loan rather than selling it. This option increases the total loan amount but gives the borrower immediate access to funds while retaining ownership of the asset.
3. Cash-in refinancing
A cash-in refinance allows the borrower to pay down some portion of the loan for a lower loan-to-value (LTV) ratio or smaller loan payments.
4. Consolidation refinancing
In some cases, a consolidation loan may be an effective way to refinance. A consolidation refinancing can be used when an investor obtains a single loan at a rate that is lower than their current average interest rate across several credit products. This type of refinancing requires the consumer or business to apply for a new loan at a lower rate and then pay off existing debt with the new loan, leaving their total outstanding principal with substantially lower interest rate payments.
Understanding Mortgage Refinancing
Mortgage refinancing replaces your current home loan with a new one. Often times, people refinance to lower the interest rate, lower their monthly payments, or tap into their home equity. Others refinance a home to pay off the loan faster, get rid of FHA mortgage insurance, or switch from a variable rate loan to a fixed rate loan.
The refinancing process is not much different from what was involved when you first bought a house and closed on your mortgage, but there are certain points to pay attention to. Understanding how refinancing works and the options available to you will help you make a more informed decision and get the best rate.
When you buy a house, you get a mortgage to pay it off. The money goes to the seller of the house. When refinancing a home, you get a new mortgage. Instead of going to the seller of the house, the new mortgage pays off the balance of the old home loan.
Mortgage refinancing requires that you qualify for the loan, just like you had to meet the lender’s requirements for the original mortgage. You apply, go through the underwriting process, and go to closing, just like you did when you bought the house.
Benefits and Reasons to Refinance a Mortgage
Before you begin, consider why you want to refinance your home loan. Your goal will guide the mortgage refinancing process from the start.
- Reduce the monthly payment: When your goal is to pay less every month, you can refinance into a loan with a lower interest rate. Another way to reduce the monthly payment is to extend the loan term — say, from 15 years to 30. The drawback to extending the term is that you pay more interest in the long run.
- Tap into equity: When you refinance to borrow more than you owe on your current loan, the lender gives you a check for the difference. This is called a cash-out refinance. People often get a cash-out refinance and a lower interest rate at the same time.
- Pay off the loan faster: When you refinance from a 30-year mortgage into a 15-year loan, you pay off the loan in half the time. As a result, you pay less interest over the life of the loan. There are pros and cons to a 15-year mortgage. One downside is that the monthly payments usually go up.
- Get rid of FHA mortgage insurance: Private mortgage insurance on conventional home loans can be canceled, but the Federal Housing Administration mortgage insurance premium you pay on FHA loans cannot in many cases. The only way to get rid of FHA mortgage insurance premiums is to sell the home or refinance the loan when you have accumulated enough equity. Estimate your home value, then subtract your mortgage balance to calculate your home equity.
- Switch from an adjustable- to a fixed-rate loan: Interest rates on adjustable-rate mortgages can go up over time. Fixed-rate loans stay the same. Refinancing from an ARM to a fixed-rate loan provides financial stability when you prefer steady payments.
Qualifying For a Home Loan Refinance
The qualifications for refinancing a mortgage are similar to the criteria for a new mortgage. Lenders will consider several factors, including:
- Credit history and score
- Payment history on your existing loan
- Income and employment history
- Equity in the home
- Home’s current value
- Other debt obligations
If you meet the lender’s standards based on these criteria, you will receive an offer in line with the risk you pose to the lender. If, for example, you have an impeccable credit history, a solid income and a lot of home equity in your home, you can get approval for better terms for a new loan.
If, however, your credit score has gone down since you got your first mortgage or you have more overall debt, you may have a harder time getting approved for more favorable terms.
Mortgage Refinancing Process: How to Refinance your Home Loans
The steps involved in refinancing are similar to applying for a mortgage for the first time. You should:
- Set your goal: Reduce monthly payments? Shorten the loan term? Get rid of FHA mortgage insurance?
- Shop for the best mortgage refinance rate: Shop around for lenders online or at a brick-and-mortar bank, credit union or lending company. Keep an eye on fees, too.
- Apply for a mortgage with three to five lenders: Submit all applications within a two-week period to minimize the impact on your credit score.
- Choose a refinance lender: To pick the best offer, compare the Loan Estimate document each lender provides after you apply. The Loan Estimate will tell you how much cash you’ll need for closing costs.
- Lock your interest rate: When you lock the interest rate, it can’t be changed during a specified period. You and the lender will try to close the loan before the rate lock expires.
- Close on the loan: This is when you’ll pay those closing costs that were listed in the Loan Estimate and again in the Closing Disclosure. Closing on a refinance is like closing on a purchase loan, with one main difference: No one hands you the keys to the home at the end.
When Is the Best Time to Refinance Your Home Loans?
It is best to refinance a home loan when one of three situations occurs:
1. When your credit score has improved
If your credit has improved since you were approved for your first loan, you may have a good chance of qualifying for more favorable terms. The higher your credit score, generally, the lower your interest rate for your mortgage loan and the better terms you’ll get for your mortgage refinancing.
You could get a lower interest rate and have more of your monthly payment going to principal and not interest if you do. Over the life of your loan, refinancing to a lower interest rate may save you hundreds or thousands of dollars in payments. Use a mortgage refinance calculator to determine how much you could save over your mortgage loan’s new term if you refinance.
2. When you need to reduce your monthly payments
If the amount of your monthly mortgage payment feels burdensome, you might reduce it by refinancing. When you refinance, you may be able to extend your repayment term, which may lead to lower monthly payments. That could mean more income to put toward other monthly expenses. Run your numbers with a mortgage refinance calculator to see how much monthly savings you’ll see.
Even if those numbers look good, make sure you’re not refinancing into a loan with a higher interest rate or less favorable repayment terms and conditions. Research the process and true costs of refinancing carefully. When you think you’ve found the right loan, ask clarifying questions of your lender about how mortgage refinancing works until you’re sure you understand your new loan before accepting.
3. When interest rates drop
Getting a mortgage with a lower interest rate is one of the best reasons to refinance. Historically, the rule of thumb is that refinancing is a good idea if you can reduce your interest rate by at least 2%. However, many lenders say 1% savings is enough of an incentive to refinance.
Reducing your interest rate not only helps you save money, but it also increases the rate at which you build equity in your home, and it can decrease the size of your monthly payment.
How to Find the Best Refinance Mortgage Lender
With so many companies offering refinancing! How can you be sure you have chosen the best mortgage company for your needs? Use these five tips to get the best mortgage refinancing possible.
1. Check Your Credit Score
Your credit score plays a decisive role in the interest rates you will see when you shop for a loan. If you haven’t checked your FICO credit score for a while, be sure to take a look before applying for refinancing. If you pay your mortgage on time every month, chances are your score has improved since you took out the loan.
2. Know Your Loan Stats
Your current loan balance and built equity will also affect the estimate of the interest you will receive when you shop. Contact your current mortgage lender and request information about your current loan balance and interest rate. This will be a great starting point for getting a new loan.
3. Research Lenders
Don’t be afraid to take plenty of time to compare refinancing lenders. Each lender charges its own set of fees and sets its own individual interest rates. Compare a few lenders and request custom quotes from each will help you find the most affordable refinance possible.
4. Browse by APR, not Interest Rate
When you shop for refinances, you’ll typically see two different percentage rates listed: your interest rate and your annual percentage rate (APR). Your interest rate is the base interest rate you’ll pay on your loan, while your APR is your interest rate plus any annual fees included on your loan. Be sure you’re comparing APRs (not interest rates) when you consider each lender.
5. Know How Much Cash You Need
Taking a cash-out refinance? Know exactly how much money you need before applying for a new loan. Consolidating credit card debt? Add all of your balances together.
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Frequently Asked Questions about Mortgage Refinancing
How do I get pre-approved?
First, you need to fill out an application and submit it to the lender of your choice. For the application you need 2 previous years of tax returns including your W-2’s, your pay stub for past month, 2 months’ worth of bank statements and the lender will run your credit report. Once the application is submitted and processed it takes anywhere from 2-7 days to be approved or denied. Check out our top lenders and lock in your rate today!
How much interest will I pay?
Interest that you’ll pay is based on the interest rate that you received at the time of loan origination, how much you borrowed and the term of the loan. If you borrow $208,800 at 3.62% then over the course of a 30-year loan you will pay $133,793.14 in interest, assuming you make the monthly payment of $951.65. For a purchase mortgage rate get a quote here. If you are looking to refinance you can get started quickly here.
How much should I save for a down payment?
Most lenders will recommend that you save at least 20% of the cost of the home for a down payment. It is wise to save at least 20% because the more you put down, the lower your monthly payment will be and ultimately you will save on interest costs as well. In the event that you are unable to save 20% there are several home buyer programs and assistance, especially for first time buyers. Check out the lenders that specialize in making the home buying experience a breeze.
How Will Refinancing Affect My Credit?
Refinancing a mortgage loan can affect your credit in a few ways. As a result, it’s important to stay attentive to your current loan and be wise about the rate-shopping process. Here are some things to keep in mind:
- Applying for a mortgage loan will result in a hard inquiry on your credit report, which can knock a few points off your credit scores.
- Multiple credit inquiries in a short period usually 14 to 45 days typically only count as one on your credit report. But if you rate-shop over the course of a few months, your scores could drop from several inquiries.
- Your length of credit history could take a hit when your old mortgage loan is closed and replaced with a brand new one.
- Your credit scores could drop if you miss a payment on your old loan during the refinancing process.
If your credit is healthy and you keep these things in mind, you may not see much of a negative effect on your credit history. But if your credit score is between fair and good, a bad decision could make it difficult to get approved for the new loan.
Conclusion
Refinancing can be a great financial move if it cuts down on mortgage payments, shortens the loan term, or helps you build equity more quickly. Used carefully, it can also be a valuable debt control tool.
When you are considering and applying for a refinance loan, it is important to know where you stand with your credit. Check your credit scores regularly to make sure you’re not blinded by negative or misinformation, and if possible, avoid taking on new credit before and during the refinancing process.
Be sure to research and compare interest rates and other terms with different mortgage lenders to see which one has the best deal for you.
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