By Sean Knight & Lauren Rosales-Shepard
Refinancing mortgage rates sounds as simple as paying off an existing loan and replacing it with a new one. Easy, right? Unfortunately, the mortgage refinance process can be more than a little intimidating, and making mistakes can cost you thousands and undermine your financial goals – the whole reason you pursued a refinance in the first place.
However, refinancing a mortgage can be a great move in many situations. It's important to understand the unique position of you and your home, your financial goals, and what a successful refinance would look like to you. If you're asking, "Should I refinance my mortgage?", you're in the right place. To help you decide if a refinance is right for you, and help avoid common mistakes, we've pulled together some key refinancing tips below.
What Does it Mean to Refinance a Home?
When you take out your original mortgage, it is to finance the purchase of your new home. So it makes sense, even at the merest level of words, that to “refinance” a home would be to replace that existing mortgage with a new one.
So far, so good–but why do people usually refinance their mortgages in the first place?
- Lower interest rate: New mortgage=new terms. One of the most common reasons for refinancing is to secure a new mortgage with a lower interest rate.
- Change loan type: If homeowners have a variable interest rate, they may favor switching to a fixed interest rate to achieve more stability in their future financial planning.
- Cash-out refinance: In a cash-out refinance, homeowners borrow more than the remaining balance of their existing mortgage. The difference is paid out to the homeowner in cash, which they can use to fulfill any financial needs.
- Remove private mortgage insurance (PMI): If a homeowner's home equity has significantly increased, they may refinance to eliminate the need for private mortgage insurance (PMI), if their original loan required it.
How Does Refinancing Work?
Assess Your Current Financial Situation
To paint yourself an accurate picture of where you stand, financially, familiarize yourself with your credit score, calculate your home equity, and determine your financial goals. Do you want to reduce your monthly payments? Are you trying to access cash to consolidate debt? Etc!
Shop Around for the Best Mortgage Lenders
Even if your current mortgage lender sends friendly, personable emails or has warm cookies in their office, there is nothing to lose – and potentially thousands of dollars to gain – by shopping around. The world of mortgages is fiercely competitive, and it's a major opportunity for you to find the lowest fees and best rates.
In fact, you can mention other offers available to various lenders and force them to compete with one another – most fees are negotiable, and in some cases, can be completely waived to win your business.
Gather Necessary Documentation
Do you recall applying for your original mortgage? You’ll need much of the same documentation for a refinance, such as pay stubs, tax returns, and bank statements.
Apply to Refinance Mortgage
Once you've identified a lender and loan product that offers the most suitable terms and aligns with your goals, you'll apply for the new mortgage.
Lock in Your Refinance Mortgage & Interest Rates
You will select the loan term (e.g. 15 years, 30 years) and the type of interest, whether it be a fixed or variable rate. There may also be an option to “float” your interest rate; a floating interest rate adjusts in tandem with economic or financial market conditions.
Submit Your Paperwork for Underwriting
The underwriters will determine your creditworthiness and assess whether you meet their criteria and the terms under which they are willing to refinance your mortgage.
Schedule a Home Appraisal
The lender will usually order an appraisal of your property to determine its current market value; this is key, because the loan amount is often based on a percentage of the property's value.
Close Your New Home Loan
If your application is approved, the lender will schedule a closing date. During the closing process, you’ll sign the new loan agreement and other required documents. You'll also pay closing costs, which typically include lender fees, title insurance, and other expenses. If you're doing a cash-out refinance or consolidating debt, you'll receive the funds at this stage.
Pay Off the Existing Loan
You will use the funds from your new mortgage to pay off your existing mortgage. The existing lender will receive the payoff amount, and your old mortgage will be closed.
Reasons to Refinance Your HomeThere are plenty of reasons to consider refinancing, but it's important to take a close look at your current loan terms, financial needs, and the lending rate landscape in general, before determining if it's right for you. We’ve already described some of the potential reasons a homeowner might have to refinance their home above, but here they are again:
Change Your Loan Term
Lower Your Interest Rate
Change Your Loan Type
Cash Out Your Equity
Reasons Not to Refinance Your HomeEvery rose has its thorns, of course, and refinancing a mortgage is no different. There is no one-size-fits-all solution to tapping into your equity, and it’s important to consider all of your options before making a decision. Here are some reasons you might not want to refinance your home:
Impact on CreditIf you miss mortgage payments during the refinancing process or immediately after, it can have a negative impact on your credit. Ensure that you continue to make your existing mortgage payments until your refinance is complete to avoid any delinquencies.
Added InterestExtending the term of your mortgage through refinancing can lower your monthly payments, but it also means you'll pay more in interest over the life of the loan.
Extended Loan TermIf you've already paid down a significant portion of your current mortgage, refinancing may not be cost-effective. The interest savings over the remaining term may not justify the overall expense of the process.
Closing Costs & FeesRefinancing typically involves closing costs, which can include fees for application, appraisal, origination, title insurance, and more. These costs can be substantial, offsetting the potential savings from refinancing.
Mortgage Financing FAQs
What does it cost to refinance a mortgage?
Before you can crunch the numbers on the various refinance options in front of you, make sure you fully understand the closing costs associated with each loan. Your lender will provide a Loan Estimate and Closing disclosure, which summarizes the terms of your loan. The Estimated Closing Costs show how much the lender is charging you for the refinance, while the Estimated Cash to Close shows how much you'll pay out of pocket to complete the loan, or depending on the nature of your loan, how much cash you're getting back.
The second page of the disclosure is usually the Closing Cost Details page, breaking down any fees you might be paying to reduce your interest rate, application fees, underwriting fees, broker fees, and more. Almost any fee here is negotiable or removable - the lender can waive it or give you “lender credits” to make up for certain fees.
With all of the correct information available, a refinance calculator can help you understand your new monthly payments, your estimated monthly savings, and your savings over the lifetime of the loan. Use the refinance calculator to compare your closing costs to the estimated monthly savings to determine your break-even point, so you can effectively plan your financial roadmap.
When should I refinance my mortgage?
If you’re thinking about refinancing your mortgage, the best time to do so is dependent on both your financial situation and goals, as well as the prevailing market conditions.
That said, one of the most common reasons to refinance is to take advantage of lower interest rates. So if market interest rates have dropped significantly since you obtained your original mortgage, refinancing can potentially lower your monthly payments and reduce the overall cost of your loan.
Additionally, if you have drastically improved your credit score since taking out your original mortgage, you may be in a position to obtain better terms. If you are also able to take on higher monthly payments, a refinance with a shorter term would help you pay off your mortgage faster and save on interest costs.
Another strategic moment for a refinance might be if your home has appreciated in value, and you have at least 20% equity. You could then refinance to remove the requirement for private mortgage insurance, which can lower your monthly payments.
What’s the difference between a second mortgage and refinancing?
Though both are financial products relating to homeownership, a second mortgage and refinancing are different. On the level of purpose, a second mortgage, often referred to as a home equity loan or a home equity line of credit (HELOC), is a separate loan that you take out while you still have your original mortgage (hence the name). The primary purpose of a second mortgage is to access the equity in your home, typically for specific purposes like home improvements, debt consolidation, or other financial needs. As we’ve already discussed, refinancing involves replacing your existing mortgage with a new one–usually to obtain more favorable terms on your current mortgage, such as a lower interest rate, different loan type, or adjusted loan term.
What are the types of mortgage refinancing?
There are multiple types of mortgage refinancing, each suited to different needs.
- Rate-and-Term Refinance: This most common type of refinance is focused on changing the interest rate and/or the loan term without significantly altering the loan amount. The main goal is to secure a lower interest rate, though borrowers can also use rate-and-term refinancing to switch from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage (FRM) for payment stability.
- Cash-Out Refinance: This type of refinance enables homeowners to borrow more than the outstanding mortgage balance and receive the difference in cash. The “cash out” can be used for financial needs such as debt consolidation, home improvements, etc.
- Cash-In Refinance: In contrast to the above, a cash-in refinance involves paying down a portion of your mortgage balance at the time of refinance. This can be done to secure a lower interest rate, reduce monthly payments, or eliminate private mortgage insurance (PMI) by increasing your equity in one fell swoop.
- Streamline Refinance (FHA and VA Loans): Streamline refinancing is available for Federal Housing Administration (FHA) and Department of Veterans Affairs (VA) loans. These programs offer a simplified refinance process with reduced underwriting requirements and documentation. Borrowers can potentially refinance without a full credit check, appraisal, or income verification. Streamline refinances are designed to help borrowers obtain a lower interest rate with minimal hassle.
- Rate-and-Term Refinance with Cash-In: As you can tell from the name, this refinance combines elements of rate-and-term and cash-in refinancing. Homeowners reduce their loan balance by making a cash payment while also changing the loan's interest rate and/or term to secure more favorable terms.
- Consolidation Refinance: This type of refinance is used to consolidate multiple loans, including mortgages and other debts (such as credit card debt), into a single mortgage. In such cases, there is often a lower interest rate that makes it beneficial.
Can I tap into my home equity without refinancing?Yes, you certainly can.
If you’re already enjoying favorable loan terms on your mortgage, why fix something that isn’t broken? There are other ways to tap into your equity–even without adding an additional monthly payment with steadily accruing interest.
With a Unison equity sharing agreement, you can obtain up to 15% of your home’s current value in cash now, in exchange for an agreed upon percentage of its future change in value later, either when you choose to sale your home, buy out the agreement, or 30 years pass. Unison has helped over 10,000 homeowners to achieve their financial goals, whether it be renovating their home, starting a small business, or planning for their retirement! Obtain a free estimate with zero effect on your credit and absolutely no obligation today.