When you take out a mortgage refinance, you're replacing your old loan with a new mortgage loan. Two of the most popular reasons to refinance are to tap the equity in your home and get a lower mortgage interest rate. No matter what your motivation, with mortgage rates hovering around all-time lows, many borrowers can benefit from knowing how to refinance mortgage loans.
There are many reasons you might want to refinance a mortgage, and many factors to take into account when you make that decision.
For example, now may be a good time to refinance because mortgage refinance rates are very low. If you lower the rate on your loan, it could save you money. Be aware, the rate you get will depend on your loan, location, credit score, income, and other factors. Not everyone will qualify for the lowest advertised rates.
You'll also need to be sure you will stay in your home for long enough to cover your mortgage refinancing costs. In order for it to be a true money-saving move, you'll break even on your closing costs before you sell or refinance again.
Mortgage refinancing can be a good idea if it will:
On the other hand, if you've already been paying down your mortgage for a long time and want to start a new 30-year mortgage to lower your monthly payment you might want to think twice. You'll pay a lot more in interest charges overall if you start the loan term over.
No matter what reason you have for refinancing, it's important to look at the pros and cons of the new loan compared to staying with your old loan.
Here are some of the most common reasons to refinance a mortgage.
Lower the interest rate: If you have a significant number of years remaining on your home loan and can qualify for a lower interest rate, refinancing might make sense.
Lower your monthly payment: A lower rate or longer term could both lower your monthly mortgage payment.
Shorter loan term: You can save money by paying off your home loan more quickly. If you can qualify for a lower interest rate, you may be able to shorten the loan term without significantly increasing your monthly mortgage payment.
Get rid of mortgage insurance: Some borrowers are required to pay a monthly and/or annual fee or mortgage insurance premium. Private mortgage insurance (PMI) on a conventional loan is canceled automatically once you have enough equity. But for other loans (including most FHA loans), the only way to stop paying this extra fee is to refinance to a new loan that does not require it.
Get cash: If you have enough equity in your home, you could do a cash-out refinance. In this instance, you'd borrow more than your current loan balance -- essentially tapping the equity in your home to receive funds in cash. This is one way homeowners pay for major home improvements.
Consolidate debt: According to the Federal Reserve, the average credit card rate in November 2020 was 16.28%. In contrast, Freddie Mac put the average 30-year fixed mortgage rate Jan. 7, 2021 at 2.65%. It might make financial sense for some people to use a cash-out refinance loan to pay off their higher interest debt. (This strategy has a couple of important caveats, so keep reading.)
Consolidating debt doesn't have to be about credit cards. Some borrowers use a mortgage refinance to consolidate other debt, such as a first mortgage and home equity loan or line of credit.
Remove someone from the loan: Sometimes, a co-borrower needs to be removed from the home loan. The way to do this is for the remaining borrower to refinance to a new loan.
Move from an adjustable-rate mortgage to a fixed-rate mortgage, or vice versa: Adjustable-rate mortgages, or ARMs, usually start out at a low, fixed teaser rate and then adjust after a certain period of time. The rate is guaranteed for an initial period, after which it can go up or down periodically along with a benchmark rate. When market rates are very low, it can be a financial advantage to refinance to a fixed-rate loan with a set interest rate.
Right now, interest rates are at rock bottom. As such, few people will financially benefit from taking out an adjustable-rate mortgage rather than a fixed-rate mortgage. However, when interest rates rise again, it could make sense to convert from a fixed-rate mortgage to an ARM. You might save money in the short term if the teaser rate on the ARM is significantly lower than your current mortgage rate and you know you will sell the home or refinance again within a couple of years.
For more on why to refinance your mortgage, read our guide.
Traditional wisdom used to be you should only refinance if you could reduce your interest rate by at least 2%. That's no longer true. Some borrowers find they can save money by refinancing even to shave half a percent off the rate. Use our mortgage refinance calculator to help you decide.
The best time to refinance a mortgage is when you can answer yes to both these questions:
On breaking even: Every mortgage loan has closing costs. And the costs involved in a refinance will be similar to your original purchase mortgage -- usually 2-5% of your loan amount. Freddie Mac puts the average refinance cost at about $5,000. The actual price you pay will depend on your location, loan size, and lender. If you see a no-closing-cost refinance, don't be fooled. There's no such thing. You'll find the costs are added to the loan balance or the interest rate is higher.
Here's how to calculate when you'll break even on your refinance. Let's say your refinance costs $5,000 and you're able to cut your monthly payment by $150. It would take $5,000/$150 = 33 months to reach your break-even point and recover your costs.
Here are the steps you need to follow to complete a mortgage refinance.
Be clear about your reason for refinancing, and as specific as possible. If you want to reduce your monthly payments or change your loan term, think about what you can afford each month and how much you'll pay in total. If you need cash out, decide how much you need before you apply so you're not tempted to go with the maximum amount you're offered unnecessarily.
Learn the details of your current loan. Gather recent statements from your current lender to see how much you owe, what your interest rate is, and how many months remain before the loan is paid off. You need to know these details in order to analyze the benefit of any new loan offer.
The best mortgage interest rates are reserved for the most creditworthy applicants. If you don't have excellent credit, find out why. You might then take steps to increase your credit score before you apply to refinance a mortgage.
The best way to spot a good deal is to comparison shop with a few refinance lenders. There's no way to know what loan terms you'll be offered unless you apply. For a true apples-to-apples comparison, it's best to make all of your loan applications on the same day, because interest rates can and do change often.
You'll need to provide mortgage application documentation. This usually includes proof of employment, recent pay stubs, bank account and asset account statements, your homeowners insurance policy details, and recent tax returns.
It won't hurt your credit score to apply with several lenders. Even though every application for new credit has the potential to ding your credit score, most scoring models recognize rate shopping. As a result, all mortgage lender inquiries made within 14 to 45 days will be counted as just one inquiry (the specific number of days in this window depends on the credit scoring model used).
When you apply for a mortgage, the lender will provide you with a loan estimate, which is a simplified form that tells you the loan's terms and costs. All lenders are required to use the same form so you can easily compare offers.
Once you choose the right option, you'll need to let the lender know you intend to proceed. You should do this as quickly as possible because the loan estimate is only good for 10 business days. If you wait too long, the lender can change the terms and costs.
It's a good idea to also let the other lenders know you've decided to get your loan elsewhere.
Before you close, you may need to provide additional documentation and pay an appraisal fee. After this, you'll need the underwriter to approve your loan, and your lender will then schedule a date to close. Many lenders will send a mobile notary to your home or office so you can sign the final loan documents. Some lenders may ask you to schedule your closing at another location. If you're required to pay closing costs, the lender will likely ask you to bring a cashier's check to the closing.
Once the closing documents are signed, the loan will be funded. If you are getting cash out, the funds will be sent to your bank account.
For more on how to refinance your mortgage, read our expert's advice.
The benefits of refinancing depend on your goal.
|Reason to refinance||Benefit|
|Lower rate||You can save money over time, or pay off your mortgage faster.|
|Cash out||You can get funds to use as you wish.|
|Lower monthly payment||A lower payment could provide immediate monthly relief in your budget.|
Here are some cases when refinancing isn't the best move.
|Sell the home a short time after refinancing||You'll lose money on fees if you haven't reached the break-even point when you sell.|
|Consolidate credit card debt||This transforms unsecured debt into secured debt with your home as collateral. Remember, the lender can't take your house if you default on credit card debt. If you default on your mortgage, it can. In addition, you could rack up your credit card balances again.|
|New 30-year loan at lower rate||You could add years to your mortgage and take longer to get out of debt.|
A traditional refinance loan simply swaps out your existing mortgage for a new one. In a cash-out refinance, you borrow more than you owe on your current mortgage, and the lender gives you the difference in cash.
You might be able to reduce your interest rate so much on the refinanced loan that you can get cash out and still have the same monthly payment.
To recap, these are the steps you'll follow to refinance your mortgage:
You should refinance your mortgage when there is a clear benefit to refinancing and you believe you will own the property long enough to break even on the costs of a refinance.
The cost of a mortgage refinance loan is similar to the cost of a purchase mortgage. The average closing costs on a refinance are $5,000. Your costs could be higher or lower, depending on the size of your loan, location, credit score, and the amount of equity in your home.
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