How Does Refinancing Work? When Should I Refinance My Mortgage?
Co-authored by:
Raul Hernandez Licensed Mortgage Loan Officer Leading “Competitive Home Lending”
Raul Hernandez is a licensed mortgage loan officer with over 20yrs of mortgage experience, a B.S. in Management and Finance, with a M.S. in Management. Currently, he leads Competitive Home Lending, a mortgage company that originates mortgage loans in Texas and Colorado, with the mission to promote direct-to-consumer wholesale mortgage loans.
When you refinance a loan, you pay off your old loan and get a new one, usually from a different lender. In general, the process is a lot like getting a regular mortgage. When you refinance a mortgage, you get a new loan to pay off your old mortgage. Before you start, you should know how the process works and the pros and cons of mortgage refinancing.
Let us Take a Look:
Deep Dive with an Expert: Co-Author Raul Hernandez Licensed Mortgage Loan Officer at “Competitive Home Lending”
Refinance?
How it works
Why Refinance?
When Should You Refinance?
What to Consider Before Deciding to Refinance
3 Major Tips for Shopping for any Home Loan
What to Consider During a Housing Market Change
Tips and Hints
How to Analyze your Situation
Count the Numbers
Put in your application.
Close Your Loan
Advantages of Refinancing a Mortgage
Downsides to Refinancing a Mortgage
Conclusion
Deep Dive with a Motgage Expert:
Co-Author Raul Hernandez Licensed Mortgage Loan Officer at “Competitive Home Lending”
Refinance?
A refinance home loan is traditionally a type of mortgage loan used to adjust the rate and term of an existing loan- known as a rate and term refinance. While a refinance can also be used to consolidate debt or for home improvements, those particular loan types are usually referred to as debt consolidation loans or home equity loans and home improvement loans, or renovation loans. Two main goals of a refinance home loan are to reduce the monthly mortgage payment and to reduce the amount of interest paid on the home loan. Here is how a refinance home loan works, how to get the best rate, and other helpful tips.
How it works
A refinance home loan is similar to a home loan used to purchase a home. The biggest difference is the fact that the borrower already owns the home. Therefore, the loan-to-value (LTV) ratio is based on the homeowner's equity and not based on a down payment.
Best Practices to Ensure if You Should or Shouldn't Refinance
Common reasons to refinance are to change a loan's term or rate with the goal of reducing monthly payments or interest paid over the life of the loan. A homeowner may decide to change a loan term from a 30yr mortgage to a shorter term such as a 20yr or 15yr term. The goal of a change in term is to reduce the amount of time remaining on the existing home loan and pay less interest over the life of the loan. A change in term can also mean refinancing from an adjustable-rate mortgage (ARM) or a balloon payment mortgage. In this situation, the homeowner is realigning the loan term to reduce the risk of increasing rates which would lead to an increase in the monthly payment on an ARM loan or paying a lump-sum balance with the end of a balloon payment's term. Another popular reason to refinance is to get a lower rate.
When Should You Refinance?
As with any refinance boom, it goes without explaining, homeowners should refinance when mortgage rates drop. A refinance is also beneficial when it makes sense to reduce a monthly mortgage payment to maintain a manageable household budget. Extending a loan's term can help reduce the mortgage payment. This is helpful when consumers need a little more flexibility with their discretionary income, or when combining a first and second lien into one mortgage for a lower payment.
What to Consider Before Deciding to Refinance
Closing costs and the breakeven point are two main things to consider before deciding to refinance. A home loan refinance has two costs a consumer must consider. The first is lender fees such as origination fee, underwriting fee, processing fee, etc. These fees can vary from lender to lender, and it is best to find a lender without excessive costs. The second cost to consider is third-party fees such as appraisal fees, title agent and title insurance fee, recording fees, and verification fees. These fees can be estimated prior to committing to a lender or running a credit report. However, these third-party fees should not vary much from lender to lender. An appraisal can be waived under certain circumstances, and title insurance can be discounted based on the age of the current title insurance policy.
3 Major Tips for Shopping for any Home Loan
Shop multiple lenders. Data from Fannie Mae states that the majority of borrowers do not shop around for the best home loan.
Work with a wholesale mortgage broker. A broker can offer the same products and services as the major lenders but at a lower wholesale rate.
Update the shortlist of lenders at the same time. Rates can change from day to day and even intraday. If rates drop, they will drop for every lender; the same goes for rate increases. An outdated quote can cause a borrower to pay a higher rate or even discount points.
What to Consider During a Housing Market Change?
A change in the housing market can affect a refinance in several ways. If housing prices are flat or begin to decline, then the loan-to-value ratio could alter the refinance terms and loan amount. Adjustments to market conditions on the secondary market can increase or decrease refinance rates. However, improvements in market conditions and home prices could offer an incentive for a homeowner to refinance even if their current rate is the same or a bit lower than current rates. An example would be to refinance from an FHA loan where the MI will continue for the life of the loan to a Conventional loan where MI is not required with an LTV of 80% or lower.
Tips and Hints
The best way to find the lowest rate is to avoid a major retail mortgage lender. Wholesale mortgage rates from mortgage brokers are usually lower. Mortgage brokers have the authorization to offer mortgage loans from the nation's best lenders at a wholesale rate. It is still wise to shop between mortgage brokers to get an even lower mortgage rate.
How to Analyze your situation:
To refinance a mortgage, you must meet the same requirements as a new loan. Lenders will examine various things, including:
The history of credit and score
Your loan's past payment history
What you make and where you've worked
Equity in the Current home value the home
Other loans and debts
So, to see if you qualify, you'll need to look at where you stand in these areas. For example, if you have a good income, good credit, and a lot of home equity, you may get a new loan with better terms. If your credit score has dropped since you got your first mortgage or if you have more debt in general, it may be harder to get better terms.
Research: Browse around
Do the preapproval process with more than one mortgage lender to compare interest rates and other terms. This will provide you with the greatest chance of getting the best deal you can get. You should also compare the terms of the refinance offers you're looking at to the terms of the mortgage loan you already have. This can assist you in determining if refinancing is a good idea.
Count the Numbers
Once you've picked the best offer, look at how much you could save and how much it could cost. For instance, if refinancing your loan with such a new lender costs you $5,000 upfront and your new monthly payment are only $100 less than what you were paying before, you'd have to live in the home for at least 50 months for refinancing to be worth it.
If you don't plan to stay in the house for very long, refinancing might not be the best choice. Also, keep an eye out for penalty fees, which can cause problems if you repay your mortgage early or remortgage again.
Put in your application.
When you're ready to send in an official application, you'll do that directly with the lender you choose. You will have to give this information about yourself, your home, and your mortgage loan. You'll also have to show proof for different parts of the application. Potential documents include:
Recent pay stubs
W-2 forms
Bank statements
Tax returns
Statements of income for a business
Investment account statements
Details about alimony and child support, if applicable
Copy of the photo ID you got from the government
Legal proof of living in the U.S.
Funding sources
If needed, a gift letter says you don't have to pay back the money you were given.
ICE Mortgage Technology, a firm that works with lenders, says that this process can take an average of 48 days from the date of the application to the date of the closing. But some lenders say they can close the deal faster.
Close Your Loan
When the lender is prepared to close the loan, you will meet up and sign some papers to make it official. Then, the creditor will pay off your first loan and set up an account for your new loan. If you get a cash-out to refinance, the money will be sent to you by check or bank transfer.
Advantages of Refinancing a Mortgage
Homeowners want to refinance their mortgage loans for several reasons.
Lower interest rate and payment:
If your credit has gotten better since you got your first loan or if market rates have gone down, you may be able to keep money on interest by getting a lower rate and monthly payment. This is possible with a loan called a rate-and-term refinance.
Change the type of rate:
With a rate-and-term refinance, you can also change your loan from having an adjustable rate to having a fixed rate. This can help you avoid the effects of market changes.
Change the length of the loan:
If you change the length of your loan from, say, 30 years to 20 or 15 years, you can usually get a lower interest rate. If you do this, you can save money on interest over the loan, but you'll probably have to pay more each month. On the other hand, you might be able to lower your monthly payment if you stretch out the length of your loan.
Get cash from your home:
If you have a lot of equity in the home, you may be able to utilize a cash-out refinance to get some of that equity. Homeowners may do this to pay off debt, make a big purchase, invest, or buy out an ex-spouse during a divorce.
Pay down your balance:
A cash-in refinance a rare way to pay off your loan. Instead of taking cash out, you will refinance your loan and put cash into it to pay down the balance. You might think about this if your loan is worth less than what you owe or if you want to get rid of private mortgage insurance.
Read Also: 10 Effective Best Practices Used by New Business Owners for 2023
Downsides to Refinancing a Mortgage
When you think about why you want to refinance your mortgage loan, it's important to consider the risks, such as how they will affect your credit. Here are several things to believe about before you start:
More interest:
If you extend the loan length, you may pay more interest throughout the new loan.
Chance of getting paid more:
If you cash out some of your equity, your new mortgage loan will be for a higher amount, which could make your monthly payment go up.
Closing expenses can be expensive:
If you expect to sell your house before you break even on closing fees, it may make sense to keep your present mortgage.
How the market is doing can change your choices:
You can't be sure that the new loan will have better terms. During times when interest rates are going up, this is especially true.
Affects length of credit history:
This credit score element, which makes up 15% of your FICO® Score, could take a hit when your old mortgage loan is paid off and replaced with a new one.
Knowing where your credit stands are important when considering applying for a refinance loan. Check your credit score often to ensure you don't get caught off guard by bad or wrong information. If possible, don't take out any new credit before or during refinancing. This can help you get your credit ready for the process and find problems that could affect your approval until the closing.
