In the realm of personal finance, mortgages play a significant role for many homeowners, allowing them to purchase their dream homes. However, as time goes by, circumstances change, and homeowners may find themselves considering refinancing their mortgage. In this blog post, we will delve into the concept of refinancing a mortgage, explore its benefits and considerations, and provide a step-by-step guide on how it works.
How Does Refinancing Work?
What is refinancing a mortgage? It essentially means replacing your existing home loan with a new one. The new loan pays off the remaining balance on your original mortgage, and you start with a new set of terms and conditions.
How does refinancing work? The refinancing process is often less complicated than the home buying process. It can be hard to predict how long it will take, but the typical timeline is 30 – 45 days.
Step 1 | Applying
Review the types of refinancing to find what works best for you. When you apply, your lender asks for the same information you gave when you bought the home. They’ll look at your income, assets, debt, and credit score to determine whether you meet the requirements to refinance, and can pay back the loan. Some of the documents your lender might need include your:
- Two most recent pay stubs
- Two most recent W-2s
- Two most recent bank statements
- Tax returns
NOTE: You don’t have to refinance with your current lender. If you choose a different lender, the new lender pays off your current loan, ending your relationship with your old lender. Don’t be afraid to shop around and compare each lender’s current rates, availability, and client satisfaction scores.
Step 2 | Locking (or Floating) Your Interest Rate
After you get approved, you may be given the option to either lock your interest rate – so it doesn’t change before the loan closes – or to float your rate. The rate lock period depends on factors like location, loan type, and lender. NOTE: If your loan doesn’t close before the lock period ends, you may be required to extend the rate lock, which may cost money. You might be given the option to float your rate, which means not locking it before proceeding with the loan. This may allow you to get a lower rate, but it also puts you at risk of getting a higher mortgage rate.
Step 3 | Underwriting
Once you submit your refinance loan application, your lender begins the underwriting process, verifying your financial information and making sure that everything you’ve submitted is accurate. This step includes an appraisal to determine the home’s value. The refinance appraisal is crucial because it determines what options are available. If you’re refinancing to take cash out, for example, then the value of your home determines how much money you can get. If you’re trying to lower your mortgage payment, the value could impact whether you have enough home equity to get rid of private mortgage insurance (PMI) or be eligible for a certain loan option.
Step 4 | Home Appraisal
You must get an appraisal before you refinance. To prepare for the appraisal, make sure your home looks its best. Tidy up and complete any minor repairs to leave a good impression. It’s also a good idea to put together a list of upgrades you’ve made to the home since you’ve owned it.
- If your home’s value is equal to or higher than the loan amount you want to refinance, it means that the underwriting is complete. Your lender will contact you with details of your closing.
- If the appraisal is low, the loan-to-value ratio (LTV) could be too high to meet your lender’s requirements. You can choose to decrease the amount of money you want, or you can cancel your application.
Step 5 | Closing On Your New Loan
Once underwriting and home appraisal are complete, it’s time to close your loan. A few days before closing, your lender will send a document with the final numbers for your loan, called a Closing Disclosure. The closing for a refinance is faster than a home purchase closing. It is attended by the people on the loan and title, and a representative from the lender or title company. At closing, you’ll go over the details of the loan and sign your loan documents. This is when you’ll pay any closing costs that aren’t rolled into your loan. Once you’ve closed, you have a few days before you’re locked in. If something happens and you need to get out of your refinance, you can exercise your right of rescission to cancel any time before the 3-day grace period ends.
When Is A Good Time To Refinance?
To know if it’s the right time to refinance, determine how long you plan to stay in your home and consider your financial goals. Think about whether your current home will fit your future lifestyle. If you’re starting a family or have an empty nest, there’s a chance you won’t stay in your home long enough to break even on the costs. These conditions, along with current interest rates, should play a role in your decision about when to refinance. As a rule of thumb, it’s worth considering a refinance if you can lower your interest rate by at least half a percentage point and you’re planning to stay in your home for at least a few years.
To determine if refinancing makes financial sense, run the numbers with a mortgage refinance calculator. To calculate potential savings, you’ll need to add up the costs of refinancing, such as an appraisal, a credit check, origination fees, and closing costs. Also, check to see if you face a penalty for paying off your current loan early. When you find out what interest rate you could qualify for on a new loan, you’ll be able to calculate your new monthly payment and see how much, if anything, you’ll save each month.
You’ll also want to consider whether you have at least 20% equity — the difference between its market value and what you owe — in your home. Home equity matters because lenders usually require mortgage insurance if you have less than 20% equity. Mortgage insurance isn’t cheap and it’s built into your monthly payment, so be sure you wrap it into calculations of potential refinance savings.
Once you have a good idea of the costs of refinancing, you can compare it with what you currently pay. You’ll spend an average of 2% to 5% of the loan amount in closing costs, so figure out how long it will take for monthly savings to recoup those costs. This is called the “break-even point”. For instance, it would take 30 months to break even on $3,000 in closing costs if your monthly payment drops by $100. If you move during those 30 months, you’ll lose money in a refinance.
If you have already paid off a significant amount of principal, think carefully before refinancing. If you’re 10 or more years into your loan, refinancing to a new 30-year or even 20-year loan — even if it lowers your rate considerably — tacks on interest costs. That’s because interest payments are front-loaded; the longer you’ve been paying your mortgage, the more of each payment goes toward the principal instead of interest.
The Benefits of Refinancing + Options
There are many benefits of refinancing, but the primary ones are to: take advantage of better interest rates, alter the loan term, switch between adjustable and fixed rates, or tap into the equity built in your home.
- Better interest rate & payment. If your credit has improved or market rates have dropped since you got your first loan, you may be able to save money on interest with a lower rate and monthly payment. You can do this through what’s called a rate-and-term refinance loan.
- Alter the loan term. You can typically qualify for a lower interest rate if you shorten your loan term. Doing so can save you money on interest over the life of the loan but may mean higher monthly payments. If you lengthen your loan term, on the other hand, you can potentially lower your monthly payment.
- Switch rate type. Another option with a rate-and-term refinance is to switch your loan from an adjustable rate to a fixed rate, which can help you avoid the impact of market fluctuations.
- Tap into the equity of your home. If you have significant equity in your home, you may be able to use a cash-out refinance to tap some of your equity. Homeowners may do this to consolidate debt, finance a large purchase, invest, or buy out an ex-spouse in a divorce.
Types of Refinancing
There are several types of refinancing options. The type you decide to get depends on your needs.
- Rate-and-Term Refinancing. This is the most common type. Rate-and-term refinancing occurs when the original loan is paid and replaced with a new loan agreement that requires lower interest payments.
- Cash-Out Refinancing. Cash-outs are common when the underlying asset has increased in value. The transaction involves withdrawing the equity in the asset in exchange for a higher loan amount. This option increases the total loan amount but gives you access to cash immediately while still maintaining ownership of the asset.
- Cash-In Refinancing. A cash-in refinance allows you to pay down some portion of the loan for a lower loan-to-value (LTV) ratio or smaller loan payments.
- Consolidation Refinancing. Consolidation refinancing can be used when you obtain a single loan at a rate that is lower than your current average interest rate across several credit products. This requires you to apply for a new loan at a lower rate and then pay off existing debt with the new loan, leaving your total outstanding principal with substantially lower interest rate payments.
- Streamlined Refinancing. Available only for government-backed mortgages from the FHA, VA, and USDA. Streamlined refinancing offers a quick, less intensive way to change your mortgage. You don’t need a reappraisal, and if you pay closing costs out of pocket, there’s not even a full credit check or income verification. This reduces the cost to refinance.
- FHA Refinancing. Compared to conventional mortgages, Federal Housing Administration (FHA) requirements are much more flexible. No matter your current mortgage, as long as you meet the FHA qualifications, you can refinance to an FHA loan, including an FHA cash-out refinance. If you already have an FHA mortgage, you could do an FHA streamline refinance and take advantage of the expedited process and smaller closing fees.
- VA Refinancing. If you’re eligible for a home loan from the Department of Veteran Affairs (VA), you can take advantage of a “regular” VA refinance, a VA cash-out refinance or, if your current mortgage is already a VA home loan, you could do a VA streamline refinance, which is called a VA interest rate reduction refinance loan (IRRRL). Consider a VA cash-out refinance if you’d like to refinance your VA mortgage so you can remodel.
Contact Dream Finders Today!
If you have other questions about refinancing a mortgage or anything else, let us know! Our Dream Finders team of experts is here to help. We can’t wait to meet with you to discuss building your dream home in one of our beautiful communities!