You may have heard that refinancing a mortgage could save homeowners thousands of dollars on their home loan. But before you decide to follow this trend, it’s important to take time to understand what is refinancing a mortgage, how it works, and what are its pros and cons. These FAQs cover some of the basic concepts of mortgage refinancing.
What does refinancing a mortgage mean?
Refinancing a mortgage means replacing the loan you currently have on your home with a new loan. The interest rate and terms of the new mortgage will be completely different from your original home loan.
How does refinancing a mortgage work?
The process of refinancing a mortgage is similar to the process of applying for a new mortgage with a few differences. Once you find a lender that best suits your needs, you complete and submit the mortgage application. You’ll need to submit your two most recent pay stubs, bank statements, and tax returns along with the application. The lender then initiates an underwriting process to verify your financial and property details. The lender may also order a home appraisal to get a current evaluation of your property.
If all is okay, the lender will send you a Closing Disclosure with terms of the new loan. On the scheduled date, you pay the closing costs and exchange your old mortgage documents for documents of your new home loan.
On approving your application, most lenders will offer you the option to lock in the interest rate. This protects your rate from potential rate hikes while your loan is being processed.
What are the benefits of refinancing a mortgage?
Refinancing a mortgage allows you to change the terms of your original home loan. You may be able to score a lower interest rate if your credit score has improved or if interest rates across the board have dropped. Even a marginal rate drop can save you a significant amount in accrued interest over the life of the loan. If your finances have improved, you can mortgage to increase the monthly payments and reduce the loan term. A shorter term means huge savings in interest and best of all, you’ll own your home outright earlier. Refinancing also helps if you need to lower the monthly payments and make them more affordable when finances are tight.
What do I need to get approved for refinancing a mortgage?
Although specific eligibility criteria vary among lenders, a good credit score of 760 or higher is a common requirement across the board. Many lenders will also require you to have a steady income and low debt-to-income ratio.
Will my original mortgage rate affect my refinancing rate?
No, the two are totally unrelated. When you apply for mortgage refinance, the lender will calculate a personalized interest rate based on your credit score, prevailing market rates, and a few other factors.
Can I refinance my mortgage multiple times?
Yes, you can. However, with closing costs of about 3% to 6% of the loan balance, refinancing a mortgage multiple times can get very expensive. This will wipe out the benefits of refinancing. You should only consider refinancing multiple times if the total savings outweighs the closing costs.
What is a cash-out refinance?
A cash-out refinance allows you to leverage your home equity. Home equity refers to the portion of your home that you’ve already paid off. It is calculated as the appraised value of your property minus the outstanding loan. Your home equity keeps increasing over time as you pay down the loan balances. With a cash-out refinance, the new mortgage has a higher loan amount than what you currently owe. When you close on the refinanced mortgage, you’ll receive the extra funds in cash. This is a great way to free up cash that you can use to pay off your higher-interest debts or for any other purpose.
How much cash can I get with a cash-out refinance?
This can vary from one lender to another but is generally about 80% of your home equity. The lender will first get your home appraised to determine the current value of your home.
What are the pros and cons of refinancing a mortgage?
Potential pros include:
- The ability to lock in a lower rate and save on the accrued interest.
- The option to clear your debt earlier by increasing your monthly payments to reduce the loan term. As an added benefit you also save money on accrued interest over the shorter term.
- The ability to free up much-needed cash by lowering your monthly payments.
- The ability to tap into your home’s equity with a cash-out refinance.
- The option to convert your adjustable rate loan to fixed rate to make the monthly payments more predictable.
- The ability to eliminate high-interest private mortgage insurance.
Potential cons include:
- Steep closing costs
- Time-consuming application process
- No guarantee of getting approved
- No guarantee of substantial savings
When is the right time for me to consider refinancing a mortgage?
Ideally, you should consider mortgage refinancing only if:
- Your home has appreciated in market value substantially
- Mortgage interest rates are falling
- Your credit score has improved enough to qualify you for a lower interest rate
- Your total savings outweigh the closing costs
- You’ve been paying down your original 30-year home loan for less than 10 years
- You intend to stay in the home for at least another two to three years
- You want to switch over from adjustable to fixed rate to lock in a lower rate
How much can I save with a mortgage refinance?
The savings will vary considerably from one homeowner to another. Your total savings will depend on your old and new interest rates, the value of your home, and underwriting, appraisal, and closing costs. You can use an online mortgage refinance calculator to calculate your savings based on your specific situation.
The first step to increasing your savings when refinancing a mortgage is to do your research and look for a lender that best suits your requirements. And, make sure it aligns with your annual budgeting goals.