Mortgage refinancing is simply the act of replacing an existing home mortgage with a new mortgage. It is much like getting your first home mortgage. Mortgage refinancing begins with an application process, continues through an approval process (called mortgage underwriting), and ends with mortgage closing.
Home lending practices have changed during the 2000’s. The new home lending requirements make it harder for lenders to give loans to people who can’t afford them. That means you’re much more likely to keep your home once you qualify for financing. Foreclosure is costly to the homeowner, the lender, and the economy.
What do you need to know about the process of refinancing your home? First, determine whether refinance is right for your situation. Then take a look at how to get it done.
Should you refinance your house?
When is it a good time to refinance? Refinance when the interest rates are low, or when you need to cash out your equity for something important.
There are basically three reasons to get a home loan refinanced:
- To lower the interest rate
- To change the payment and/or term (length) of the loan
- To cash in the equity you’ve got in the home
How to know if mortgage refinancing is right for you
Though those are the three basic reasons, there are many situations that could lead to any one of these. For example, you might want to lower your current interest rate. When interest rates dip, it’s a good idea to refinance. If your current mortgage is a variable rate, you might want to refinance when rates are low to get a good fixed rate.
People also refinance to get out of paying the ongoing FHA mortgage insurance. If your current home loan is an FHA loan, you will pay FHA mortgage insurance every month for the length of the loan, unless you go through the steps to have it stopped.
Refinancing is another way to get out of paying those premiums, which can amount to tens of thousands of dollars over the life of the loan.
You might also go for refinancing to lower your payments. Say, for instance, that one spouse decides to quit work or cut down to part-time to stay home with the kids. Or, maybe you get a job making less money than you used to. Both of these are good reasons to refinance your mortgage. Refinancing stretches out the length of the loan and lowers your payments.
On the other hand, many homeowners find themselves in a better financial situation than they were when they got their first loan. They might refinance to a shorter term to pay off their loans faster. For instance, they might refinance their 30-year mortgage to a 15-year mortgage.
Homeowners also refinance to get their cash equity out. They sell back the part of the loan they’ve paid off, get the cash, and then begin repaying it back again. There are several reasons to do this. Some homeowners refinance for cash to pay off other debts, as a means for debt consolidation. Many homeowners want the money for home repairs, to start a business, or take a vacation.
Another common reason for mortgage refinance is divorce or a breakup. The partners refinance the home, putting it all in one of their names. Then, the one who’s keeping the home uses the cash to pay the other for his or her part of the home’s value. This serves the dual purpose of taking one name off of the mortgage while also allowing the couple to get access to the cash value they are entitled to.
If you need to ….
Lower your interest rates (or keep them low)
- Lower your payments
- Pay off your loan earlier
- Get cash out of your home
… mortgage refinancing is probably right for you.
Do you qualify for mortgage loan refinancing?
Homeowners can pay closing costs out of pocket, or they can usually have the mortgage lender roll those costs into the new loan.
Just like when you closed on your current mortgage, the refinancing process ends with closing, and that costs money. There are two ways to handle closing costs: pay it out-of-pocket or have the costs financed into the new loan.
In cases where getting your cash equity is the reason for refinancing, you’ll probably want to finance the closing costs into the new loan to keep as much cash as possible on hand. But if you are trying to get the loan payments reduced or get the home paid off faster, it’s a good idea to pay closing costs out of pocket, if possible.
What is the ‘break-even point’ for mortgage refinancing?
The break-even point is the point at which the borrower recoups the cost of refinancing through the savings. For example, say you refinanced your mortgage and the closing costs were $6,000. After refinancing, you save $300 per month on your payments. It will take you 20 months to reach your break-even point:
$6,000 ÷ 300 = 20
Unless you’re keeping the house for at least two more years, it wouldn’t make sense to refinance. Only refinance your home loan when you plan to stay long enough to pass your break-even point and begin saving money.
How to compare mortgage refinancing options & lenders
Just like shopping for your first home, it pays to shop lenders and look into refinancing options. Some lenders have lower interest rates or more flexible loan terms. Others may offer great deals on closing costs or have less strict guidelines for loan qualification. Just be sure to do the math. If a lender is willing to work with you on a lower credit score, they may charge more interest. In this case, you might not save enough on refinancing to make it worthwhile. Make sure the math makes sense before agreeing to a refinancing loan.
Remember, interest rates fluctuate on a daily basis. As soon as you get a good loan rate negotiated with your lender, get it in writing so that it’s locked in. That way, if mortgage rates happen to go up in the next few days or weeks, you won’t be stuck paying the higher rate.
Types of refinancing loans
There are several terms to know to understand the types of refinancing loans you’re offered.
A loan scheduled to be paid off in monthly payments over 15 years. You can usually get a better interest rate on a 15-year loan, but the payments are generally higher.
This loan is paid off over the course of 30 years. The interest rates for 30-year loans are often higher than for 15-year loans, but the payments are lower.
Fixed Versus Variable
Fixed rate loans mean that the interest rate stays the same for the length of the loan (usually 15 or 30 years). Variable rate loans mean the interest rate goes up or down based on the prime interest rate at any time. Variable rates are usually much lower than fixed rates when interest rates are low. But, these interest rates can skyrocket when the prime rate goes up, causing your payments to soar, too.
If your house is worth more than you owe on it, you may be able to refinance the home and get the cash equity out.
This option requires you to pay closing costs out of pocket. It is usually done to fix an “upside-down loan”, to get out of paying mortgage insurance, or to avoid the rising interest rates of an existing variable-rate mortgage. (Upside-down loans, or “under water” mortgages, are when you owe more on the house than its current market value.)
The Federal Home Affordable Refinance Program, or HARP for short, allows homeowners who are struggling financially to refinance their homes up to 125 percent of the house’s value.
The government’s “streamline” program is a way for homeowners with FHA loans to refinance without a lot of paperwork.
There are also state government programs to help homeowners avoid foreclosure, as well as finance programs for veterans. Speak to your mortgage lender about any government refinancing programs you may qualify for.
Rate & Term Refinancing
Rate and term refinancing is when the existing mortgage is totally paid off and a whole new loan is issued. Most refinancing options are rate and term refinancing.
A short refinance is when a mortgage lender pays off your current mortgage and replaces it with a brand new loan with a lower balance. This is done to help homeowners avoid foreclosure. It’s sometimes offered by lenders as an option to short sale or foreclosure.
Most of the same banks and mortgage lenders that offer mortgages also offer refinancing options. Find the best mortgage companies here .