A mortgage refinance replaces your existing home loan with a new one. Often people refinance to lower the interest rate, slash monthly payments, or tap into their home’s equity. Others refinance a home to pay off the loan sooner, get rid of FHA mortgage insurance, or move from an adjustable-rate to a fixed-rate loan.
When you purchase a home, you get hold of a mortgage to pay for it. The money goes to the home seller. When refinancing a home, you obtain a new mortgage. Instead of going to the home’s seller, the new mortgage pays off the balance of the old home loan.
Mortgage refinancing needs you to be eligible for the loan, just as you had to meet the lender’s conditions for the original mortgage. You file an application, go through the underwriting procedure, and go to closing, as you did when you purchased the home.
The article will explore the home refinance process, when should you refinance your mortgage, the truth about refinancing your mortgage, and more.
Table of Contents
- 1 When Should You Refinance Your Mortgage?
- 2 Home Refinance Process
- 3 How Much Can You Refinance a Mortgage?
- 4 Home Refinance Options
- 5 The Truth about Refinancing Your Mortgage
- 6 Refinance Home Loan Calculator
When Should You Refinance Your Mortgage?
Before you start, think about why you want to refinance your home loan. Your goal will steer the mortgage refinancing procedure from the beginning.
- Cut the monthly payment. When your goal is to pay less every month, you can refinance into a loan with a lower interest rate. Another method to reduce the monthly payment is to lengthen the loan term — say, from 15 years to 30. The downside 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 provides you a check for the difference. This is referred to as cash-out refinance. People every so often get hold of a cash-out to 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. Due to this, you pay less interest over the life of the loan. There are benefits and drawbacks to a 15-year mortgage. One drawback is that the monthly payments usually rise.
- Get rid of FHA mortgage insurance. Private mortgage insurance on conventional home loans can be revoked, but the Federal Housing Administration mortgage insurance premium you pay on FHA loans cannot in many cases. The only means to get rid of FHA mortgage insurance premiums is to sell the home or refinance the loan when you have amassed enough equity. Approximate your home value, then deduct your mortgage balance to determine your home equity.
- Shift from an adjustable- to a fixed-rate loan. Interest rates on adjustable-rate mortgages can increase over time. Fixed-rate loans remain the same. Refinancing from an ARM to a fixed-rate loan gives financial stability when you desire steady payments.
Home Refinance Process
The process of refinancing is like getting a mortgage when you buy your home.
Step 1: Set an unambiguous financial goal.
There should be a good explanation of why you’re refinancing, whether it’s to lower your monthly payment, shorten the term of your loan or pull out equity for home repairs or debt repayment.
If you’re lowering your interest rate but restarting the clock on a 30-year mortgage, you may end up paying less every month, but moreover the life of your loan. That’s for the reason that the majority of your interest charges are in the early years of a mortgage.
Step 2: Check your credit score and history.
You’ll need to be eligible for a refinance, just as you are required to get authorization for your original home loan. The higher your credit score, the better refinance rates lenders will extend you — and the better your prospects of underwriters granting your loan.
It may make sense to spend a few months improving your credit score prior to initiating the refinancing procedure.
Step 3: Decide how much home equity you have.
Your home equity is the value of your home more than what you owe the bank on your mortgage. To find it out, check your mortgage statement to look at your current balance. Then check online home search sites or get hold of a real estate agent to run an analysis to discover the current estimated value of your home. Your home equity is the difference between the two. For instance, if you still owe $250,000 on your home, and it is worth $325,000, your home equity is $75,000.
You may be able to refinance a conventional loan with as little as 5 percent equity, but you’ll get hold of better rates and fewer fees if you have more than 20 percent equity. The more equity you have in your home, the less perilous the loan is to the bank or lender.
Step 4: Explore multiple lenders.
Getting quotes from multiple lenders can spare you thousands of dollars. Once you’ve selected a lender, examine when it’s best to lock in your rate, so you won’t have to be concerned about rates rising before your loan closes.
In addition to evaluating interest rates, pay attentiveness to the cost of fees and whether they’ll be due up front or rolled into your new mortgage. Lenders occasionally offer “no-closing-cost loans” but charge a higher interest rate or add to the loan balance.
Step 5: Be transparent about your finances.
Assemble recent pay stubs, federal tax returns, bank statements, and anything else your lender demands. Your lender will also see your credit and net worth, so reveal your assets and liabilities honestly.
Having your documentation prepared prior to beginning the refinancing process can make it go more efficiently.
Step 6: Prepare for the appraisal.
Some lenders may need a mortgage refinance appraisal to decide the home’s current market value for a refinance approval.
You’ll pay a few hundred dollars for the appraisal. Letting the lender know of any upgrades or repairs you’ve made since buying your home could result in a higher appraisal.
Step 7: Come to the closing with cash, if required.
The closing disclosure, as well as the loan estimate, will state how much money you require to pay out of pocket to close the mortgage.
You might be able to finance those costs, which normally amount to a few thousand dollars, but you’ll be expected to pay more for it through a higher rate or loan amount.
Step 8: Keep checks on your loan.
Store copies of your closing paperwork in a secure place and establish auto payments to make it certain you stay up to date on your mortgage. Many lenders will also offer you a lower rate if you register for auto-payment.
Your lender might resell your loan on the secondary market either instantly after closing or years later. That entails you’ll owe mortgage payments to a different company, so keep an eye out for mail informing you of any such alterations.
How Much Can You Refinance a Mortgage?
Refinancing your mortgage can be an exceptional source of funds to consolidate debt, complete a home renovation, or to send your children to post-secondary education. In Canada, you can refinance your mortgage up to a loan-to-value ratio of 90%. A loan-to-value ratio is the total mortgage amount divided by the home value.
For instance, let’s say you own a home worth $200,000 and have $150,000 left to pay on it.
Current mortgage: $150,000
Home value: $200,000
If we take the mortgage amount and divide it by the present home value we obtain a loan-to-value ratio of 75%. If you want to borrow money from your home, you can borrow up to 90% of the home value as stated above.
Using the above illustration, let’s first find out how much you could possibly borrow in a refinance.
Maximum mortgage: $200,000 * 90% = $180,000
Then, we’ll take that amount and deduct the amount remaining on your mortgage to discover how much you can borrow.
$180,000 – $150,000 = $30,000
Though refinancing may be cost-friendly, it’s crucial to take into account and understand all of the costs involved. To ascertain if refinancing is the most financially feasible option, you must think about the best mortgage rates and other costs involved and compare this to other financing alternatives such as a line of credit.
How Much Does It Cost to Refinance a Mortgage?
The average closing costs for a mortgage refinance are about $5,000, even though costs differ according to the size of your loan and the state and county where you live, according to data from Freddie Mac. Normally, you can anticipate paying 2 percent to 5 percent of the loan principal amount in closing costs. For a $200,000 mortgage refinance, for instance, your closing costs could run $4,000 to $10,000.
Here’s a summary of the fees commonly involved in refinancing closing costs:
|Application fee||$75-$300 or more|
|Origination and/or underwriting fee||0.5%-1.5% of loan principal|
|Recording fee||Cost depends on location|
|Appraisal fee||$300-$400 or more|
|Credit check fee||$25 or more|
Home Refinance Options
Refinance mortgages come in three forms — rate-and-term, cash-out, and cash-in. The refinance type that’s suitable for you will be based on your personal finances. Refinance rates differ between the three types.
A rate-and-term refinance allows homeowners to change their existing loan’s mortgage rate, loan term, or both. The loan term is the duration of the mortgage.
For instance, a homeowner may refinance:
- From a 30-year fixed-rate mortgage into a 15-year fixed-rate mortgage
- From a 30-year fixed-rate mortgage with a 5% interest rate to a new 30-year mortgage with a 3% fixed rate
- From a 30-year fixed-rate mortgage with a 5% interest rate to a 15-year fixed loan at 3%
The aim of a rate-and-term refinance loan is to save money. You do this either by obtaining a lower monthly payment or paying less interest on the whole due to a lower mortgage rate or a shorter loan term.
If you refinance into a shorter loan term, your monthly payments will be higher. That’s for the reason that you’re paying off the same amount of money in a shorter amount of time. But, because you’re removing years of interest payments, you save more money in the long run.
Most refinances are rate-and-term refinances, particularly in a falling mortgage rate environment.
The objective of a cash-out refinance is to utilize your home equity.
Home equity is the part of the home that you own. For example, if your home is worth $300,000, and you owe $200,000 on your mortgage, you have $100,000 worth of home equity. But equity isn’t liquid cash. To gain access to it, you have to get a loan against the value of your home. That’s where a cash-out refinance comes in.
Keep in mind that with a rate-and-term refinance, your new loan balance is equivalent to what you currently owe on the home, and it’s utilized to pay off your current mortgage. The difference with a cash-out refinance is that your new loan balance is bigger than what you currently owe.
The new loan is utilized to pay off your existing mortgage, and the money “leftover” is the amount you’re cashing out.
Here’s a simple example to demonstrate how cash-out refinancing works:
- Home value: $300,000
- Current loan balance: $150,000
- New loan balance: $200,000
- Cash received at closing: $50,000 (less closing costs)
Because the homeowner owes only the original amount to the bank, the “additional” amount is paid as cash at closing. Or, in the case of a debt consolidation refinance, the cash-out is guided to creditors such as credit card companies and student loan administrators.
Cash-out mortgages can also be utilized to consolidate first and second mortgages when the second mortgage was not taken at the time of buying.
In a cash-out refinance, the new loan may also provide a lower interest rate or a shorter loan term compared to the old loan. But the key objective is to produce liquid cash — hence getting a
A lower interest rate isn’t needed.
Cash-out mortgages signify more risk to a bank than a rate-and-term refinance mortgage, so lenders need more strict approval standards. For instance, a cash-out refinance may be restricted to a lower loan size as compared to a rate-and-term refinance; or, the cash-out refi may need higher credit scores at the time of application.
Most refinance loan programs also need borrowers to leave at least 15% to 20% of their home’s equity available. That implies you won’t be able to withdraw all your home equity, but only a part of it.
Cash-in refinance mortgages are the converse of a cash-out refinancing.
With a cash-in refinance, the homeowner brings cash to closing to pay down the loan balance and reduce the amount owed to the bank. This may lead to a lower mortgage rate, a shorter loan term, or both. There are numerous reasons why homeowners prefer the cash-in mortgage refinance procedure.
The most common reason is to get hold of lower interest rates which are accessible only at lower loan-to-value ratios (LTVs).
LTV measures the size of the loan compared to the home’s value. Refinance mortgage rates are often lower at 75% LTV, for instance, as compared to 80% LTV.
Another common reason to cash-in refinance is to rescind the mortgage insurance premium (MIP) payments. When you pay your conventional loan down to 80% LTV or lower, your private mortgage insurance premiums are no longer due. This rule is not applicable to FHA loans, which normally need mortgage insurance premiums throughout the life of the loan.
Nevertheless, a homeowner could reinstate an existing FHA loan with a conventional loan through the refinance procedure. This plan could remove mortgage insurance premiums and assist you to save even more month-to-month.
The Truth about Refinancing Your Mortgage
Home mortgage refinancing can seem enticing to homeowners seeking to reduce expenditures. But it’s not always a good plan. Based on your condition, refinancing can either save you money or trigger a variety of problems. While the temptation of lower interest rates and smaller monthly payments makes sense at first glimpse, it’s important to comprehend the possible risks involved.
In general, you should avoid refinancing your mortgage if you’ll waste money and increase risk. It’s easy to fall into the traps below, so make sure you are well aware of these common mistakes.
Extending a Loan’s Term
When you refinance, you normally extend the amount of time you’ll repay your loan. For instance, if you get a new 30-year loan to replace your existing 30-year loan, payments are determined to last for the next 30 years. If your existing loan only has 10 or 20 years left to go, refinancing is expected to result in higher lifetime interest costs.
This is because when you get hold of a new loan with a long term, most of your payments mainly go toward interest charges in the early years. But with your current loan, you might have already moved past those years, and your payments might be making a profound dent in your loan balance. But if you refinance, you must start from scratch. To prevent losing significant ground, you can decide to use a shorter-term loan, such as a 15-year mortgage.
To see this in action, insert your numbers into a loan amortization calculator to see exactly how the interest costs alter (along with your monthly payment). While you’re at it, learn how amortization works if you’re inquisitive about the procedure of paying down loan balances.
Refinancing a home loan costs money. You normally pay fees to your new lender to reimburse them for extending the loan. You may pay a range of charges for legal documents and filings, credit checks, appraisals, and so forth.
Even if a loan is advertised as a “no closing cost” loan, you still pay to refinance. In many instances, that happens through a higher interest rate than you would otherwise pay. To better comprehend no closing cost refinance loans, explore the basics of such loans to avoid common downsides.
When you select a loan with “no closing costs,” you may pay a higher rate for the life of your loan instead of paying one-time fees.
You can make use of home equity to consolidate debts. To do so, you might refinance your current loan with an even larger loan. Also called cash-out refinancing, this method offers extra cash that you can make use of to pay down credit cards, auto loans, and other debts.
Debt consolidation may seem alluring because you lower interest rates on your debt by transforming consumer debts into lower-interest-rate home equity debts. But that move can go wrong if all you do is free up capacity on your credit cards and stack up more consumer debt. Shifting debt around is not the same as paying it off.
It can also fail if you are not capable to pay the larger loan balance and take the risk of losing your home. If you are having difficulty paying consumer debts, consider twice before placing your home on the line. Consider registering in a debt consolidation program prior to taking such a radical step.
In some states, home purchase loans have extraordinary protection from creditors: In the occurrence of foreclosure, lenders might not be permitted to sue you if they lose money on your loan and ensuing home sale. Those legal actions, referred to as deficiency judgments, can disturb you even after you leave your home.
But those rules are applicable to your original purchase loan, and refinancing your mortgage modifies the nature of your loan: It’s no longer the original loan you used to buy your home. Due to this, you may lose some protection.
Refinance Home Loan Calculator
Once you’ve chosen to refinance, it’s time to compute the numbers. Making use of a refinance home loan calculator can assist you to discover the best mortgage.
You’ll be required to know (or make some informed guesses about) your new interest rate and your new loan amount.
After you enter the data, the tool will determine your monthly savings, new payment, and lifetime savings, taking into account the estimated costs of refinancing your home.
It also will reveal your refinance “break-even” point. Getting a mortgage usually requires paying fees, often amounting to thousands of dollars. It takes a while for a refinance to break even — that is, for the amassed monthly savings to surpass the refinance closing costs.
Working with a refinance calculator will give you a good sense of what to anticipate. Even better, when you have a few quotes from mortgage lenders you can insert the terms they offer you into the calculator to help decide which one offers the best deal.
Refinancing can be a fantastic financial move if it lowers your mortgage payment, shortens the term of your loan, or facilitates you to build equity more swiftly. When utilized wisely, it can also be a useful tool for bringing debt under control. Before you refinance, take a thorough look at your financial condition and ask yourself: How long do I intend to continue living in the house? How much money will I save by refinancing?
Again, bear in mind that refinancing costs 2% to 5% of the loan’s principal. It takes years to recover that cost with the savings produced by a lower interest rate or a shorter term. Therefore, if you are not intending to stay in the home for more than a few years, the cost of refinancing may counteract any of the potential savings.
It also pays to consider that a savvy homeowner is always exploring methods to decrease debt, create equity, save money, and get rid of their mortgage payment. Taking cash out of your equity when you refinance does not assist to accomplish any of those goals.