Refinancing a Mortgage: A Complete Guide
As the name implies, refinancing a mortgage entails obtaining a new loan to settle down an existing mortgage. Usually, it comes with a new loan balance and interest rate. Your lender will consolidate your financial responsibilities by using your new mortgage to pay off your current one.
Refinancing is a common move made by homeowners. You can utilize a rate-and-term refinance or a cash-out refinance to tap the equity in your home for financial needs. Refinancing can also be used to remove a borrower from the mortgage, which typically happens in divorce cases. Finally, you may even add a second cosigner to the mortgage.
Before you start the process of refinancing a mortgage, it’s essential for you to comprehend how it works and the benefits and drawbacks.
What Does Refinancing a Mortgage Mean?
To refinance is to replace the previous mortgage with a new one. You can use the proceeds from your new mortgage – whether it comes from the original lender or a new one entirely – to settle the old mortgage and close the associated account. After that, until the loan is paid off, you are legally obligated to follow the conditions of the new mortgage (or refinanced again).
The refinancing procedure will include some familiar elements from the previous mortgage loan process, but will often be considerably simpler and quicker for the borrower. The application and underwriting processes are quite similar to those of a first-time homebuyer loan, including verification of your credit history, income, and current debt load. If you get a loan, the lender will provide you with their exact conditions and your options for paying them back.
Depending on your property, your finances, and the sort of loan(s) you’re applying for, the entire process could take anything between a couple of days to a month or over. It’s important to shop around for a mortgage to find the best rate and terms for your situation. You shouldn’t always stick with your first lender.
How Does Refinancing a Mortgage Work?
The process of determining your qualification for the best possible interest rate on your mortgage is very similar to the one that occurred initially when you applied for the loan. It’s a fresh mortgage from a new lender, not necessarily the one who helped you buy your house originally.
The timer on your old loan may not carry over to the new one. Let’s pretend you’ve been paying on your 30-year mortgage for five years now. That amounts to a remaining debt term of 25 years. A fresh 30-year loan would mean starting the repayment process all over again. You can save yourself five years of loan payments by refinancing into a new 20-year loan.
Closing expenses for a refinance can make or break the decision to switch mortgages. In general, you should expect to pay anywhere from 2% to 5% of the amount you’re refinancing in fees. Discount points, an origination charge, and an appraisal fee are all examples of common closing fees. If you want to know if you’ll be able to repay the closing fees while also benefiting from the reductions of the refinance, you need to figure out the break-even point.
Why Should You Refinance a Mortgage?
Is it really worth the effort, not to mention the paperwork and money, involved in refinancing? Refinancing is worth the effort and cost for several reasons:
- The interest rate that you pay can be reduced. The main advantage of refinancing is the possibility of a cheaper interest rate. A reduced rate of interest can save you a ton of money over the life of your loan, either your credit has improved drastically since you initially obtained your mortgage or even the market has changed. However, unless you acquired your mortgage at least ten years ago, you probably won’t save any money with a refinance.
- You can apply for a different type of loan. It’s possible that you’re considering refinancing your mortgage from an adjustable rate to a fixed-rate product, or that you’re expecting to eliminate your monthly premium for FHA mortgage insurance by converting to a conventional loan. By refinancing, you can compare different mortgages and decide which one best fits your needs.
- Increase your borrowing capacity by tapping into your equity. The benefits of refinancing extend beyond financial savings, since it may also allow you to have access to more finances. With a cash-out refinance, you can use your home’s equity as collateral to get a larger loan. This will increase your debt, but it will allow you to pay for major needs (like renovations or school) at a lower interest rate.
- Your loan term length is negotiable. Consider refinancing your 30-year mortgage into a 15-year loan if you still got 20 years left on your debt and want to save money in the long run. The mortgage could be paid off sooner, but the increased monthly payment could be a burden.
Refinancing a Mortgage: Pros and Cons
Consider the benefits and drawbacks of refinancing a mortgage to determine if it’s the best option for you.
Pros
- There’s a chance your interest rate will drop.
- You might be able to have some extra funds each month if you lessen your mortgage payment.
- If the term were cut, your loan might be repaid sooner.
- At the closing table, you can receive a portion of your home’s value in cash.
- Refinancing is sometimes used by homeowners to consolidate several obligations, including credit card debt and school loans, into a single, manageable monthly payment.
- Depending on your needs, adjustable-rate and fixed-rate mortgages can both be used.
- Private mortgage insurance might be omitted, saving you money.
Cons
- All fees associated with the closing must be paid by you.
- A longer loan term might raise your total amount of interest paid and delay the day when the debt is fully repaid.
- You run the risk of having less equity in your house if you take out a loan against it.
- You might regret buying if interest rates decrease dramatically after you close.
- Refinancing is a drawn-out process that could take up to 45 days or more.
- There will be a brief decline in your credit score.
When Does Refinancing a Mortgage Make Sense?
When deciding whether or not to refinance your mortgage, you should think about whether the benefits will justify the costs. Many homeowners may benefit from at least calculating the possibility of a refinances when:
- Your credit score rises thus giving you access to higher interest rates and lending terms.
- The recent decline in market rates has made it possible for you to qualify for more favorable loan arrangements without affecting your credit score.
- A cash withdrawal from your home’s equity is necessary.
There is no set rule of thumb for when homeowners should consider refinancing their mortgage. In general, refinancing can be a terrific opportunity to modify your mortgage loan to meet your needs even better if the numbers are appropriate; nevertheless, there are consequences to refinancing too early after purchasing the house, such as further reductions to your credit score or introducing lender wariness.
Take into account the length of time you plan to stay in the house and the savings from the new loan before deciding to refinance. Consider how long it will take for your cost savings from the refinancing to equal or exceed the costs of the new loan.
Final Thoughts
Refinancing is an excellent strategy to utilize your home’s equity when the moment is perfect. To cut costs over the life of the loan, you can shorten or lengthen the term, switch to a different loan type, or negotiate a lower interest rate. Another option is to take a loan against the value you have built up in your property.
