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Mortgage Refinancing for Dummies

Joan PabonJun 27, 2017

Refinancing your mortgage is essentially replacing your existing mortgage with a new one. Whether you are refinancing your mortgage to save on interest, switch from a variable to a fixed rate, or release equity from your home, the process of refinancing can be complicated and entail a good deal of research and careful planning.

Benefits and Risks of Refinancing

Before choosing to refinance, keep in mind how valuable an asset your home is, and that refinancing could entail considerable drawbacks if the terms of your new mortgage are not as favorable as those of the first. Here are some points to consider:

  • What is the current value of your home?
  • How much have interest rates dropped?
  • How much do you still owe?
  • How much are you paying monthly?
  • How long do you plan on keeping your home?

Most homeowners refinance their mortgage to save on interests, lower their monthly payments, shorten the term of their mortgage, consolidate debt, or release equity for other expenses. The primary reason for refinancing, however, tends to be lowering their current interest rates. This could potentially mean greater savings, a reduction of monthly mortgage payments, and an increase in the equity of the home, which is the difference between the market value of the home and its outstanding mortgage.

Others consider refinancing as a way to pay off or consolidate debts and increase the value of their homes. After an appraisal, lenders will usually approve the homeowner for a percentage of its total value. When the balance of the previous mortgage is subtracted, and the remainder is disbursed, savvy borrowers can use that money to make home improvements and increase the value of the property. Potentially, this means they can sell their home for more and pay off the mortgage entirely, or even qualify for a different financing option such as a home equity line of credit (HELOC).

One thing to avoid, however tempting it may be, is extending the term of the loan just for the sake of lowering monthly costs. A longer term than your current one, means you’ll end up paying more in interest overall. Also, be on the lookout for lenders who promise no closing costs for refinancing your home, as some will conceal their closing costs among interest rates and fees.

Types of Mortgage Refinancing

Rate and Term Refinance – The most common method of refinancing, this allows you to renegotiate your loan’s interest rate and term. This could be a good option for borrowers who have an adjustable-rate mortgage and want to switch to a fixed-rate mortgage , in order to obtain greater stability.

Cash-out Refinance – This type of loan allows you to refinance your mortgage for more than what you already owe and get the difference in cash. If you’re looking to increase the value of your home, a cash-out refinance loan could release enough capital from your home equity to cover renovation expenses. Keep in mind that a greater loan amount will entail higher monthly payments, but that those can be offset by a lower interest rate.

Cash-in Refinance – This type of loan is essentially the opposite of cash-out refinancing. With this option, you bring cash to the table to help lower your mortgage balance and increase the equity of your home. This is a great option for individuals who want to reduce their loan terms, or whose homes have declined in value and can’t qualify for other refinancing options.

Government Refinance Loans – The Home Affordable Refinance Program (HARP) allows homeowners to refinance their mortgage and take advantage of lower interest rates, even those with little or no equity. You may qualify for HARP if your loan is owned or backed by Fannie Mae or Freddie Mac, you’re current on your payments, and your mortgage was originated on or before May 31 of 2009.

Short Refinance – With this alternative, lenders refinance your existing mortgage and provide a new, reduced loan amount to help you avoid foreclosure. This is beneficial to both homeowners and lenders, as the costs of foreclosure are usually higher.

Who Qualifies for Mortgage Refinancing?

Mortgage Refinancing can be a long process and involve a good deal of paperwork. Lenders typically require specific documentation besides their application form, such as a minimum of two years of employment and residence history. They will also invariably require financial information such as income, assets, and credit verification. Homeowners looking to refinance must have good credit –no less than 620–, as banks and lenders all set minimum credit score requirements that vary depending on the type of refinancing option. You may be ineligible for mortgage refinancing if you’ve filed for bankruptcy or are undergoing foreclosure.

Besides completing an application and having a healthy credit score, borrowers are also asked to provide evidence of employment and steady income. Borrowers who are self-employed may be asked to provide evidence of income through bank account statements or tax returns for the previous two years. Banks and lenders will also likely require an appraisal of the home, both to determine its value and to weigh that against the amount you are looking to borrow. If the value of your home has depreciated and you owe more on your mortgage than you originally borrowed, some lenders may deny you the possibility of refinancing or offer you less favorable loan terms. Consider all refinancing options carefully to determine which one is right for you. Even if you don’t qualify for refinance through a bank or lender, HARP could still be a viable option.

Use a Mortgage Refinance Calculator

The process of shopping around and comparing prices can be greatly expedited by using a mortgage refinance calculator. This tool can give you a better idea of what to expect in terms of refinancing costs and savings. You will need to provide basic information about both your current mortgage and the new one. Make sure you know the outstanding principal on your current mortgage, its loan terms, interest rate, and current monthly payments. You should also know the details of the new mortgage, which should include the above information, as well as the closing costs and cash-out amount, if applicable. A mortgage refinance calculator can help you determine your new monthly payments and savings, as well as any differences in interest.

How Expensive is Refinancing a Mortgage?

The total fees associated with refinancing a mortgage tend to range between 2% and 6% of the outstanding principal. Closing costs, also referred to as settlement costs, vary depending on your state and the type of refinance you opt for. These may include, but are not limited to:

Application Fees –The lender charges a fee to process the loan and run a credit report. Application fees can cost anywhere from $80 to $300, depending on the lender.

Title Search and Title Insurance –There will be a charge for researching public records to verify you are the legal owner of your property and that there are no liens or encumbrances on the property. You may also be asked to purchase a policy to cover the costs of any inconsistencies that arise during that process.

Appraisal Reports –To determine the value of your home, some lenders may require an appraisal report.

Loan Origination Fees – The origination fee covers the work involved in preparing your mortgage loan and the paperwork it requires. Origination fees can cost up to 1.5% of the principal.

Document Preparation and Attorney Fees – The company or attorney that conducts the closing typically charges the lender a fee for services rendered. The lender, in turn, may ask the borrower to cover settlement expenses.

Shop Around

Before choosing a bank or lender to refinance your mortgage, make sure to compare the products and programs they offer. There are many online tools that allow you to compare lenders and products, shop around for the type of loan that meets your needs, and locate providers in your area. Don't be afraid to ask questions and get as much information as you can about the terms of the loan. Lenders are required by law to provide you with an estimate within three days of receiving your basic information, so make sure to go over all the details they provide. When comparing products, try not to focus on a single factor such as low interest rates, and instead consider the total cost of the loan and its repayment schedule. Watch out for balloon payments, hidden fees, a prepayment fee, and amortization schedules that could put off payments towards the principal loan amount for too long.

What You Should Know Before Applying:

If you are decided about refinancing your mortgage, you already know there are additional expenses or closing costs associated with the process. Be prepared and set aside sufficient funds to cover settlement costs and fees. Closing costs vary depending on the state as well as the lender, so make sure there are no additional expenses such as local fees for transfers and taxes, or inspection fees that are solely applicable in your state.

Before starting the application process, gather all the documentation you may need, including your credit score and the current value of your home. You’ll bea asked for a considerable amount of detailed financial information, such as evidence of your income, employment, debts, and assets. The more documentation you’ve gathered together beforehand, the more expedited the application process can be.

Some lenders may offer mortgage rate locks to keep you protected from the possibility of interests rising during the loan application process, but make sure there is a provision in place that allows you to take advantage of falling rates as well. A rate lock-in will cost you, so consider how the option will benefit you and if that benefit outweighs the cost.

Finally, compare estimates from different lenders using a mortgage refinance calculator and create a break-even estimate once you have decided on a particular lender. The estimate will help you calculate how long it will take you to recover your investment in refinancing costs, and figure out exactly how much you will benefit from a lower mortgage rate.