When you refinance your home mortgage, you are essentially swapping your current home loan with a new one that offers you a new (presumably better) interest rate. Additionally, the term of the loan – whether it’s 15, 20, or 30 years – may be adjusted as well. So if you’ve paid five years on a 30-year loan, refinancing may require you to start at 30 again. Conversely, refinancing also may offer you the opportunity to shorten your term.
Before you select a new loan, be sure to shop around for the best rates. Whether you wind up with your current lender or someone new, it will be their role to pay off the old loan and finance the new one. That’s why it’s called refinancing.
Two Types of Refinancing
There are two basic types of refinance loans: rate-and-term and cash-out.
A rate-and-term means you refinance to take advantage of a lower interest rate or a better term. Any funds from the loan are used to pay off the old mortgage.
A cash-out means you are borrowing additional money based on the equity in your home. You can use this additional cash to pay off debts, remodel your home, or any other way you see fit.
Reasons You Might Want to Refinance
If you’re scratching your head and wondering why you would want to refinance, know there are several of reasons, including:
- Secure a lower interest rate
- Change from an adjustable-rate to a fixed-rate loan
- Reduce your monthly payments
- Consolidate your debts
- Remove someone from the loan
Keep in mind it’s not always necessary to refinance. An alternative solution – depending on your ultimate goal – might be to obtain a home equity loan or a home equity line of credit.
Calculating Whether or Not to Refinance
Choosing to refinance needs to be considered carefully. Just because it lowers your monthly payment may not be enough reason alone to make it a good deal.
Consider if you had a $170,000 30-year home mortgage that you’d paid on for five years:
New Refinanced Loan
|Cost of Loan|
Your savings ($1,312 – $1,075) per month would be $237. However, you would now have extended the term of your loan back to 30 years. So you would have 60 additional payments of $1,075 or $64,500.
What it Takes to Get Refinanced
Before you decide that refinancing your home is the way to go, make sure you know what is involved.
Refinancing is similar to applying for a first home loan. Your lender will review your income, assets and liabilities, debt-to-income ratio, and current credit score. This may have changed (for good or bad) since you obtained your original loan. You lender also will determine your current property value (based on an appraisal).
Your lender will then consider the amount of your loan request and determine if your loan-to-value ratio (LTV) is acceptable. The LTV is an estimate of how much you owe versus the current market value of your home.
Be aware that there are costs associated with refinancing. They may vary by lender, but often include:
- Refinancing fees (based on principal)
- Application fee
- Loan origination fee
- Appraisal fee
- Inspection fee
- Closing fee
- Title search fee
- Survey fee
- Prepayment fee
Additionally, you will need to provide proof you have homeowner’s insurance. And if you have a government home loan, there may be an associated fee.
Home Affordable Refinance Program (HARP)
If you’re current on your mortgage payments and still can’t get traditional refinancing because the value of your home has declined, you may be eligible to refinance through the Federal Housing Finance Agency (FHFA). HARP is designed to help homeowners get a more affordable mortgage.
To be eligible for HARP, your mortgage must:
- Be owned or guaranteed by Freddie Mac or Fannie Mae
- Have been sold to Freddie Mac or Fannie Mae on or before May 31, 2009
- Not have been refinanced under HARP previously (except under Fannie Mae from March to May, 2009)
Additionally, your current LTV ratio must be greater than 80% and you must have a good payment history over the past 12 months.