Ultimate Guide to Mortgage Refinance

Everything you need to know about mortgage refinance

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Mortgages represent the largest component of household debt in America. This makes mortgage refinances one of the biggest opportunities for reducing debt and interest payments.

When you refinance your home mortgage, you’re swapping your current home loan with a new one that offers you a new (hopefully better) interest rate. You may also adjust the term of the mortgage refinance loan – whether it’s 15, 20, or 30 years. So if you’ve paid five years on a 30-year loan, refinancing may require you to start at 30 again. 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.

Reasons you might want to refinance your mortgage

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 goal – might be to obtain a home equity loan or a home equity line of credit.

Pros and cons of refinancing your mortgage

Keep in mind, refinancing your mortgage has many pros and cons. Examine each factor as it relates to your specific situation to figure out if refinancing is the right move for you.

WEIGH THE RISKS AND BENEFITS

Here is a list of the benefits and the drawbacks to consider when refinancing your mortgage.

Pros
  • Lower interest rate.
  • Lower your monthly payments.
  • Convert an adjustable-rate mortgage to a fixed-rate
  • Remove someone from the loan.
  • Borrow against your home’s equity.
Cons
  • Extending your loan term could cost you more money.
  • Could be denied if your credit or income has dropped.
  • High fees and costs.

Types of mortgage refinancing 

Now that you understand the pros and cons of refinancing, here are the types of refinancing loans you’re offered.

15-year loans and 30-year loans

A loan scheduled to be paid off in monthly payments over 15 years or 30 years. You can usually get a better interest rate on a 15-year loan, but the payments are generally higher.

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 skyrocket when the prime rate goes up, causing your payments to soar, too.

Cash-out refinancing

A cash-out refinance is a loan to refinance your mortgage and get a lump-sum of cash by using the equity in your home as security. Home equity is the difference between the value of your property and the amount you owe on it. So if your property is worth $400,000 and you owe $250,000 on your mortgage, you would have $150,000 in equity.

When you have equity, you can refinance your mortgage and take out a loan that is greater than the amount you owe on your existing mortgage.

Cash-in refinancing

A cash-in refinance is a mortgage refinance that requires you to pay down your existing mortgage to under a certain loan-to-value ratio to qualify. Loan-to-value is calculated by taking your mortgage divided by the value of your property. For example, many lenders will not consider refinancing a mortgage with a LTV higher than 80%.

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.)

Government refinancing

The Federal Home Affordable Refinance Program, or HARP for short, has ended. However, there are HARP alternatives offered by Fannie Mae and Freddie Mac. See below for more details on how to qualify for a HARP alternative.

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-and-term refinancing

Rate-and-term refinancing pays off your current mortgage and issues a new loan. Most refinancing options are rate-and-term refinancing.

Short refinance

A short finance helps homeowners avoid foreclosure. The mortgage lender will pay off the current mortgage and replace it with a loan with a lower balance.

Refinance options to repay high-interest debt

If you have a large amount of debt, refinancing your mortgage can save you money. Here are several alternative refinancing options to help you manage your debt.

Consider a cash-out refinance

If you qualify for a mortgage refinance to eliminate debt and would benefit from the savings, consider a cash-out refinance to consolidate and pay off your other debts.

A cash-out refinance involves getting a new loan with a lower interest rate for a larger amount than the existing mortgage loan. As the borrower, you receive the difference between the two loans in cash to use as you please.

In this case, you’ll be using the cash to pay off your high-interest debt like credit cards, a car loan, or a personal loan.

With this strategy, you can consolidate debt into a home loan and pay it off at a much lower interest rate.

Borrow against the equity in your home

Another option would be to get a home equity loan or line of credit to pay off debt.

home equity loan allows you to use your home equity as collateral to borrow a fixed amount of money. You’ll receive the money upfront, which you then have to make payments on (usuallyover a period of-of 15 or 30 years, for example). The amount of equity in your home will determine how much you qualify for, as will your payment term, income, and credit history.

home equity line of credit (HELOC) allows you to borrow against the equity in your home for a fixed period. It’s a revolving line of credit (usually a percentage of your home’s equity) that allows you to access money when you need it. Similar to a credit card, you can borrow what you need, pay off the balance, and then borrow again.

Remember, the amount of equity you have in your home equals the market value of your home, minus what you owe. Using our example above, let’s say you have $100,000 in equity and would like to borrow some of that value to pay off your high-interest debt.

You can apply for a HELOC and be given a period where you can withdraw the funds you need on an ongoing basis, just like with a credit card. The only difference is that you’re not required to make payments immediately. You can pay back the funds you borrowed after the draw period ends.

Review and compare HELOC lenders here

How much will it cost to refinance my mortgage?

Many homeowners would like to refinance but may worry about the closing costs. Refinancing isn’t free, but it might not be as expensive as you believe, and there’s an easy way to avoid most of the costs. Either way, refinancing can be smart if you have a good reason to do it and expect to benefit from it.

The costs you’ll usually have to pay fall into two buckets:

Origination fees charged by your lender

Lenders charge a variety of loan origination fees, which vary by state. These include origination fees, originator fees, points, commitment fees, document preparation fees, lender fees, processing fees, and underwriting fees. The table below shows a range of typical fees, but lenders don’t usually charge all of these fees. More likely, you’ll see a wide range of fees from different lenders.

Although these fees have different names, they can be the same. These fees are the amounts the lender charges you for underwriting, processing, and originating your new loan.

Some origination fees are based on a percentage of your loan amount while others are flat fees. Fees that defined as “points” are percentage-based. One point equals 1% of the loan amount.

Third-party fees

Examples of third-party fees include appraisal fees, attorney fees, and closing fees. Some lenders break it down further into settlement fees, credit report fees, survey fees, flood certification fees, title search, title insurance, and recording fees. Fees vary depending on the lender and their service providers. The table below shows a range of the fees you can expect to pay. Again, lenders don’t usually charge all of these fees. More likely, you’ll see a wide range of fees from different lenders.

Third-party mortgage refinancing fees vary by state. The differences between states are much larger for third-party fees than origination fees. The average in 2017 was around $1,133.

Refinancing Without Paying Fees or Closing Costs

If you don’t want to pay fees to refinance, you can choose a no-closing-cost or low-closing cost loan.

This type of loan eliminates many of the upfront out-of-pocket fees. However, you receive a higher interest rate for your loan. That will make the loan more expensive every month that you keep it.

Ask your lender for all costs for a no-closing-cost or low-closing cost loan up front. This will help you determine which option is right for you. Your decision might depend on how long you plan to keep your loan and how much cash you have on hand to pay costs out of pocket.

If you want to preserve your cash for other priorities, a no- or low-closing cost refinance could be an attractive option. A mortgage refinance could save you thousands of dollars if you do it right, and that begins with doing the proper research.

What it takes to get refinanced

Before you decide that refinancing your home is the way to go, make sure you know what’s 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. Your information might 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).

Next, your lender will 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.

Additionally, lenders will want to see proof of homeowner’s insurance. If you have a government home loan, additional fees may apply.

Home Affordable Refinance Program (HARP)

The Home Affordable Refinance Program ended on December 31, 2018. See below for HARP alternatives you may qualify for if you’re not eligible for a regular mortgage refinance.

HARP eligible homeowners could save an average of $2,400 a year on mortgage payments with a HARP refinance. To qualify homeowners had to continue making mortgage payments but not qualify for a traditional refinancing because the value of your home dropped. They also had to follow the following eligibility guidelines:

  • Fannie Mae or Freddie Mac purchased the mortgage on or before May 31, 2009.
  • The mortgage must have been previously refinanced under HARP  unless it was a Fannie Mae loan refinanced under HARP from March-May 2009.
  • The current loan-to-value (LTV) ratio must be greater than 80%.
  • Each borrower had to be current on the mortgage at the time of the refinance with a good payment history in the past 12 months.

 HARP replacements

Fannie Mae and Freddie Mac have rolled out alternatives to HARP that could help homeowners that don’t qualify for regular mortgage refinances.

Both programs only accept mortgages that originated after October 1, 2017, and you cannot refinance a HARP mortgage.

To qualify for a HARP alternative the refinance must provide one of the following benefits:

  • Lower monthly principal and interest payment.
  • Shorter loan term.
  • A fixed-rate mortgage instead of a variable-rate mortgage.
  • An interest rate reduction.

As well as those requirements homeowners must also:

  • Have a minimum of 12 on-time payments.
  • No 30-days late payments in the last six months.
  • A maximum of one 30-day late payment in the last year.

What if I don’t currently qualify for a HARP alternative?

The U.S. government recently settled with five large banks accused of mortgage abuses. Part of this $26 billion settlement stipulated that $3.5 billion be dedicated to support refinancing underwater mortgages that are not owned or guaranteed by Fannie Mae or Freddie Mac. If you don’t meet Fannie Mae or Freddie Mac requirements, but your mortgage is serviced by Wells Fargo, Bank of America, JP Morgan Chase, Citibank or Ally/GMAC, you may qualify for refinancing under this settlement.

Finally, you may be able to obtain a loan modification from your lender. While this is not a traditional refinance, it may still lower your mortgage rates and payments.

Calculating whether to refinance your mortgage

Refinancing a mortgage is about the numbers. Whether you’re seeking a lower monthly payment or looking to shorten the length of a mortgage, refinancing typically only makes sense if you can reduce the overall cost of the loan.

Just because a refinance lowers your monthly payment may not be enough reason alone to make it a good deal.

Refinancing can be a great idea if it is used to save money by shortening the length of your loan, reducing your interest rates or both. Don’t rush into a mortgage refinance that increases the term of the loan. It can be an expensive mistake to make.

Let’s say you have a 15-year loan and refinance to one that is a 30-year, chances are you will lower your payment but will pay much more to finance your home than if you kept your original loan. Or, with a lower interest rate, you may be tempted to refinance your 30 year-fixed loan to another loan with the same repayment schedule of 30 years starting payments all over again. This just keeps you in debt much longer and accruing interest along the way.

How the federal tax cut and jobs act will impact your refinance

Federal and state laws change from time to time. Staying up-to-date will help you make an educated decision when it comes time to refinances.

Take, for instance, the federal Tax Cut and Jobs Act signed into law in December 2017 was a big deal for homeowners. So big that it could motivate some to refinance their mortgage or pay it off altogether.

The biggest impact of these changes is that homeowners now need a larger dollar amount of itemized deductions to make itemizing a better strategy than taking the standard deduction.

For some, the benefit of itemizing will disappear, making mortgage interest and SALT irrelevant for income tax purposes.

Here’s an example:

For the 2017 tax year, if a married couple paid mortgage interest of $15,000 and property tax of $3,000, their itemized deductions totaled $18,000, or $5,300 more than their standard deduction.

Their tax bill would be lower if they were to itemize. The amount saved would depend on their income tax bracket.

Now, with the standard deduction raised to $24,000, this couple wouldn’t benefit from itemizing, despite their $18,000 of itemized deductions. Instead, the standard deduction would lower their tax bill more.

The upside is that taxpayers who switch to the standard deduction will no longer need to keep track of all the expenses they deducted on Schedule A.

Should you refinance your mortgage?

So, what’s the bottom line? That’s the question of the hour and, the truth is, the answer depends on the person who’s asking. But now that you know the pros and cons of refinancing, you have a good idea whether it’s the right move for you.

Regardless of which direction you’re leaning in, though, it’s always a good idea to do more research and talk to different lenders. You may learn that you’re actually leaning in the wrong direction. Or, you might get confirmation that you’re making the right decision.

To find out for sure, start by comparing mortgage refinance lenders side-by-side and narrow down your top three options. Then, get in touch with those lenders to discover how much money, if any, you could save by refinancing your mortgage with them.

The more you know, the closer you’re to making the right decision.

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