Homeowners

Easy Steps to Refinance Your Home

If you've been following the news lately, you may know that mortgage rates are just about as low as they've ever been. And that may have you thinking about refinancing your mortgage.

Given that mortgage rates are lower than ever before, refinancing may be a smart financial decision for many homeowners, but it's important to understand the process before you contact a lender.

But before we get to the process, here's a little more information about what a refinance is.

What is a refinance?

When you refinance your mortgage, your existing loan is paid off and replaced with a new one, potentially with different terms. There are many reasons why someone may want to refinance their mortgage. Perhaps you want to take advantage of a situation where the prevailing market interest rate is lower than your interest rate or maybe you'd like to change the term of your mortgage.

There are also several different types of refinances. Let's take a quick look at each one.

What are the types of refinance programs?

Rate and term: It's the most popular option for borrowers who want to lower their interest rate. In a rate and term refinance, the change in loan term may result in a reduction in the monthly mortgage payment.

Cash out: This option increases the amount a homeowner is borrowing and enables homeowners to tap into their home equity and pull cash out, which they can use in any manner they'd like.

HELOC: A HELOC, or Home Equity Line of Credit, is another option that allows borrowers to pull cash out. In a HELOC, the borrower can pull out what they need, when they need it, as opposed to receiving a lump sum at the closing table like a cash-out refinance.

Cash in: The opposite of a cash-out refinance. In this instance, a borrower pays down their loan balance and essentially resets their loan with a lower principal amount.

Now that we know a little bit more about refinancing, here are a few easy steps that will help you determine if refinancing is right for you and help make the process easier if you decide to proceed:

1. Examine your financial situation and goals

Before contacting a lender, it's important to consider why you may want to refinance. Are you interested in decreasing your monthly mortgage payments? If so, refinancing your mortgage to one with a lower interest rate may be a good decision if current rates are below what they were when you took out your current mortgage. But it's important to know that refinancing might not make financial sense for you, depending on your existing interest rate, how recently you took out your current mortgage, or whether you'd like to extend the term on your current mortgage or not.

Alternatively, if you're interested in decreasing the term on your mortgage, perhaps from a 30-year term to a 15-year term, then refinancing may make sense. The 15-year mortgage is an intriguing option for many borrowers as it typically has a lower interest rate than its 30-year counterpart, but since the term is shorter, the payment will likely be higher than it would be if the loan was being paid back over 30 years.

Another reason one may want to refinance is to eliminate your mortgage insurance payment if you have an FHA loan. FHA loans require both an upfront payment for mortgage insurance and separate monthly mortgage insurance payments for as long as the life of the loan, depending on the loan-to-value ratio. Depending on your financial situation, refinancing an FHA loan into a conventional loan may be a way to rid yourself of the mortgage insurance payment.

You may also want to take equity out of your home, perhaps to do some home improvements. If that's the case, a cash-out refinance or a HELOC may be a sound decision.

One way to help you make the decision is to use our refinancing calculator to determine if refinancing may help your budget.

2. Do your research

It's important to arm yourself with information before exploring a refinance. First, check your credit score and your credit reports. You are entitled to a free credit report every year from each of the three major credit reporting agencies – Equifax, Experian, and TransUnion – through AnnualCreditReport.com. It should be noted that due to the COVID-19 pandemic, consumers can get a free copy of their credit report every week through at least April 2021.

It's also important to know an estimate of your home's value. Many of the top real estate sites will have a property value estimate for your home if you search by address. You can also research recent comparable home sales in your neighborhood to get an estimate of your home's value.

3. Get your documents together

When you refinance, regardless of what type of loan it is, you are taking out a new loan so you'll need to provide documentation that will be used to verify your income, assets, and debts. You'll likely need your recent W-2s and pay stubs. Depending on your situation, you may also be asked for your tax returns and bank statements for any accounts you have. This is used to help determine whether you have enough money, either coming in or on hand, to pay your new mortgage.

It's also good to review your monthly debts, including your current mortgage, credit cards, student loans, auto loans, any existing HELOCs, and other debts. A lender will look at these when calculating your debt-to-income ratio, which is the amount of your monthly gross income that goes toward covering your monthly debts.

4. Talk it out

It comes down to one question when figuring out if it makes sense to explore a refinance: how long will it take for refinancing to pay for itself? If you plan on moving soon, you may not be able to recoup the closing costs (generally 2% to 5% of the mortgage balance) paid to close your refinance. However, if you can live in your home past the break-even point (the number of months it will take to recoup your closing costs), a mortgage refinance may be financially beneficial in the end.

Make sure you discuss the prospect of refinancing with people you trust and discuss all the reasons why it makes sense (or doesn't make sense) to move forward.

5. Contact a lender

If you've gone through all the above steps and determined that refinancing your mortgage may be worth exploring, it's time to contact a lender. The lender will be able to walk you through the entire process and help you decide if it makes financial sense for you to refinance. The lender may also present you with different refinancing options depending on your financial situation and goals.

6. Be patient

Once you've contacted a lender, don't assume that you're going to be closing on your new loan immediately. Make sure you read through all the documents your lender sends to you, especially the Loan Estimate form, which provides the costs associated with your loan.

Many lenders will allow you to lock in your interest rate for 30-60 days, with some going as high as 120 days. That enables both the borrower and the lender to take the appropriate time to make sure that everything is in order before closing.