What is a mortgage refinance?
Your home is an asset worth hundreds of thousands of dollars.
Refinancing allows you to leverage that asset by unlocking lower monthly payments, cashing out equity for unplanned expenses, or locking in a shorter loan term to save thousands of dollars in mortgage interest.
Essentially, refinancing is when you trade in your current mortgage loan for a new one. And the results can have a significant impact on your financial situation.
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Mortgage refinance meaning
Refinancing your mortgage means you take out a brand new mortgage loan to replace your old one. The refinance process looks a lot like when you bought your house — including a full mortgage application — except that there’s no purchase agreement or home inspection to worry about. You’re simply taking out a new loan on the same property that will benefit you financially.
Is a mortgage refinance right for you?
People refinance for many reasons. The decision to refinance or not depends on interest rates, closing costs, how many years you will remain in your house, and whether refinancing saves you enough money.
It may take months or years for the savings from refinancing to cover the costs of refinancing. You’ll want to see how long it takes to break even before you refi.
“You need to look at the whole picture if you are refinancing your home,” says Greg Iverson, senior mortgage broker at F&B Financial Group in St. Louis.
He adds, “Don’t just ask about the interest rate. You need to pay attention to what it all translates to because you can always lower an interest rate by paying points and closing fees.”
In other words, If you choose to buy down the rate, then take the cost associated with the buy down and look at how much additional savings you get from doing so. Then see how many months it will take for this savings to equate to the total cost of the rate.
Top reasons for refinancing a mortgage loan
Refinancing a mortgage can solve many problems. Some include lower monthly mortgage payments, accelerating repayment of your mortgage balance, cashing out home equity for other needs, removing former partners from the property title, and dropping mortgage insurance.
Cash out home equity
In markets where homes have appreciated a lot, homeowners could refinance to take cash out for home improvements,” says Iverson.
You can borrow against the value of your home using a cash-out refinance loan. Essentially, you replace your existing mortgage with a larger, new mortgage and take the leftover as a lump sum of cash to use however you like.
Many borrowers use the funds from a cash-out refinance to update their homes, invest in additional real estate, finance unexpected expenses, and even pay down high-interest debt from credit cards, debt consolidation loans, home equity lines of credit (HELOCs), and more.
Lower your mortgage interest rate
One of the most popular reasons for refinancing is the opportunity to lower your mortgage interest rate. You may be able to do it by refinancing to a different loan, for example, exchanging an adjustable-rate mortgage with a fixed-rate loan, or a 30-year loan term into a 15-year term product.
You may be able to reduce your rate if your credit scores have improved, if the value of your current home has risen, or if the mortgage market is better than it was when you got your original mortgage loan.
If you did not shop carefully for your current loan, and are paying a higher interest rate, you may be able to fix that mistake by refinancing now.
Speed up repayment by shortening your loan term
Some borrowers refinance their current homes to get a shorter term for their mortgage loan. They may have been paying on a 30-year loan but want to get done quicker, and rates for shorter terms are significantly lower.
“The most popular shorter term is a 15-year mortgage,” Iverson says.
“Sometimes, their income has increased, and they want to increase their monthly payments to get done quicker paying off the house,” he adds.
Refinance into a fixed-rate mortgage
When interest rates are on the rise, homeowners with ARMs get nervous. If your interest rate can increase, and you plan to keep your home more than a couple of years, consider refinancing.
As an example, exchanging your adjustable-rate 30-year mortgage for a 30-year fixed-rate loan can provide peace of mind with regular monthly mortgage payments, if not a lower interest rate.
Drop your private mortgage insurance
Private mortgage insurance (PMI) drops automatically once you pay down your loan to 78% of the purchase price. However, if your property appreciates in value, you can drop PMI sooner by refinancing into a new loan.
If you have a 30-year FHA mortgage that closed in 2013 or later, you don’t get to drop mortgage insurance no matter what your loan-to-value (LTV) is. The only way to avoid that expensive coverage is to refinance.
Mortgage refinancing options
In mortgage lending, “conventional” simply means, “not government-backed.” That’s it. Conventional loans can refer to any program that is not FHA, VA or USDA.
If you choose one of these and don’t have a 20% down payment or equity in your house, you usually pay private mortgage insurance premiums.
Conventional loans are usually less costly than government loans if you have good credit or don’t require mortgage insurance.
Conforming home loans
Conforming loans are simply conventional loans that conform to guidelines established by Fannie Mae and Freddie Mac. They buy mortgages that meet their guidelines and sell them to investors.
This makes underwriting their loans less risky for mortgage lenders, and often less expensive than other conventional loan programs.
Jumbo mortgages are just loans too big to meet Fannie and Freddie guidelines. In most cases, that means loans larger than $.
However, the conforming limit is higher in areas with expensive housing markets — up to $ in the Lower 48, and even higher in Alaska, Hawaii, the US Virgin Islands and Guam.
This government-insured loan offers several refinance options, including the FHA Streamline Refinance.
You can refinance from an FHA loan into a new FHA loan without getting an appraisal and without income verification, or minimum credit scores. FHA also offers a cash-out refinance and a 203(k) remodeling loan.
The VA also offers a streamline refinance called the Interest Rate Reduction Refinance Loan, or IRRRL. Like FHA’s version, mortgage lenders require no appraisal or income verification, and there is no minimum FICO score. Although many lenders will have their own in-house credit score minimums.
While you can only use a VA mortgage to purchase a primary residence, you can streamline refinance even if you converted the home to a vacation property or rental.
Low- to moderate-income homebuyers in USDA designated rural areas, which includes small towns and suburbs of big cities, are eligible.
The USDA program does not allow cash out, but there is a streamline option to refinance easily.
How does mortgage refinancing work?
The refinancing process is similar to the home buying process, but you won’t need to worry about home inspection fees, real estate agent commissions, earnest money, or bringing a down payment to closing.
Our home refinance checklist provides a detailed step-by-step guide to help homeowners prepare to refi their current homes into a new mortgage.
1. Set your goals
The first step in the refinancing process is to establish a clear goal. What is the benefit of a new loan, and what type of loan is best suited to your financial situation?
Tools like refinance calculators can help you estimate whether or not a refi will help you save money over the life of the loan. Additionally, you can begin to get a sense of what mortgage rates you might qualify for by pulling free copies of your credit report.
Your credit history is a primary deciding factor in whether your new loan will have a higher or lower rate. So if you discover that your credit has dropped or that you now have bad credit, be sure to improve your score before speaking with a mortgage lender.
2. Submit a loan application
Once you understand what your goals are, it’s time to shop your refinance rate around by requesting quotes from multiple lenders. You may even be able to obtain official Loan Estimates from more proactive mortgage providers without having to submit a formal mortgage application.
With rate quotes and Loan Estimates in-hand, evaluate the multiple offers to see which lender can give you the best deal on your new mortgage loan.
3. Underwriting and appraisal
After you’ve decided on a lender and submitted a mortgage application, your loan officer will begin to work on underwriting your new home loan.
The underwriting process entails verifying your financial details and the information about your home. To help them, you’ll pay for a home appraisal — just like you did when you first purchased your home.
The appraiser will estimate the value of your home. If the appraisal comes in lower than expected, you have the option to cancel you application or decrease the loan amount.
Alternatively, you can do what is called a cash-in refinance by bringing cash to closing to qualify for the original loan terms.
With a refi, you’ll have a mandatory three-day waiting period known as the “Right of Rescission.” It’s a short window before your loan funds that gives you time to change your mind and cancel the application.
Keep in mind that the Right of Rescission only applies to refinancing a primary residence, not second homes or investment properties.
Be sure to closely examine all of the loan terms, including mortgage interest rate and closing costs — comparing your initial Loan Estimate with your lender’s Closing Disclosure (CD).
Most of the numbers should remain the same, but sometimes figures on the CD may change. Be sure you understand which elements have changed and why.
What Are Today’s Refinance Rates?
Current mortgage rates are low and may be good enough to make a refinance worth doing.
However, interest rates, loan terms and fees vary widely between lenders. To get the best deal, compare several quotes and pick the best deal.