While homeowners typically opt for 15- or 30-year mortgages, it’s crucial to understand that a mortgage isn’t a “set it and forget it” financial instrument. Many individuals choose to refinance their home loans for various reasons, such as reducing their monthly payments, securing funds for home improvements, or accelerating their mortgage payoff timeline. Strategically, mortgage refinancing can be a very sensible financial decision.
Here are essential aspects of mortgage refinancing you should be familiar with.
What Does Home Refinancing Involve?
Refinancing a mortgage entails substituting your existing home loan with a new one. This new loan commonly features revised terms, including the interest rate, the principal balance, the final repayment date, and the monthly installments. Essentially, the new mortgage is used to settle your current loan, and from then on, you make payments on this newly established mortgage.
Why Consider Refinancing Your Mortgage?
Although some believe that mortgage refinancing is only beneficial when interest rates are particularly low, there are numerous situations where evaluating home loan refinancing makes good financial sense:
- Mortgage rates have decreased. Even a slight reduction in prevailing mortgage rates could mean you can borrow money at a more advantageous interest rate.
- You require cash. If you’re looking to finance home renovations, cover college tuition expenses, or consolidate high-interest debt, refinancing your mortgage can allow you to access the equity built up in your home.
- You aim for a quicker loan payoff. You might want to shorten your loan’s duration, perhaps from a 30-year term to a 15-year one, to pay off your house more rapidly.
- You are paying mortgage insurance. If your home equity reaches 20% or more, refinancing your mortgage might enable you to eliminate ongoing FHA mortgage insurance or private mortgage insurance premiums.
- You wish to change loan types. A mortgage refinance offers the flexibility to switch from an adjustable-rate mortgage to a fixed-rate loan, or from an FHA loan to a conventional one.
- Your financial situation has changed. If your credit score has improved, your home’s value has appreciated, or you can comfortably afford higher payments, you may qualify for a new mortgage with a lower interest rate than your current one.
Different Kinds of Mortgage Refinancing
Refinancing a home loan is generally less intricate than purchasing a home, as you’re not engaged in negotiations with a seller. Nevertheless, there are multiple refinancing options available, each designed to meet distinct needs.
- Rate and Term Refinance: This is the most straightforward form of mortgage refinancing, focusing on adjusting your interest rate, your loan term, or both. For instance, if you prefer to extend your payments over a longer period, you might refinance into another 30-year loan. This could potentially lower your monthly payments, especially if you also secure a more favorable interest rate. Conversely, if your goal is to accelerate your loan payoff, you can opt for a shorter loan term.
- Cash-out Refinance: With this type, you convert a portion of your home’s equity into a cash payout. Your new loan balance will increase by the amount of cash you receive, which is added to the remaining principal of your existing loan.
- Cash-in Refinance: If your objective is to reduce your monthly mortgage payment, you can refinance and contribute additional cash at the closing. This extra payment effectively lowers the amount you need to borrow. Instead of a down payment for a new home, you’re “putting cash in” to decrease your loan balance, which can reduce your debt and potentially help you qualify for a lower interest rate.
- No Closing Cost Refinance: While typical closing costs for a mortgage refinance range from 2% to 5% of the loan amount (though they can vary), a no-closing-cost refinance allows you to incorporate these expenses into your new loan rather than paying them upfront in cash. Generally, this means your monthly payment—and possibly your interest rate—will be slightly higher.
- Short Refinance: If you are experiencing financial difficulties and find yourself unable to meet your monthly mortgage obligations, you might be able to negotiate with your lender to refinance into a mortgage with lower payments. In such cases, the lender may agree to forgive the difference in previous monthly payments.
- Reverse Mortgage: Available to individuals aged 62 or older, a reverse mortgage can provide you with a lump sum or regular monthly payments drawn from your home equity. However, it’s crucial to understand that reverse mortgages can involve substantial borrowing costs and might complicate your estate for your heirs. Exercise caution when evaluating these heavily advertised financial products.
- Debt Consolidation Refinance: Similar to a cash-out refinance, this option allows you to leverage your home equity through mortgage refinancing. The cash obtained would then be used to pay off other debts, such as high-interest credit card balances or other outstanding loans.
- Streamline Refinance: Certain home loan programs, including conventional loans and government-backed options, offer a streamline refinance to some well-qualified borrowers. This type may allow them to bypass certain documentation requirements, simplifying the process.
The Process of Refinancing Your Mortgage
Just like securing an original mortgage to purchase a home, refinancing requires a structured, step-by-step approach. Typically, the mortgage refinance process can take between 30 and 45 days to complete.
- Clarify Your Objectives: Before initiating a mortgage refinance application, it’s vital to identify your specific reasons for doing so within the context of your broader financial strategy. The particular refinancing option you choose will depend heavily on this goal, whether it’s debt elimination, reducing your monthly payment, accelerating your payoff date, or transitioning to more favorable loan terms.
- Assess Your Current Financial Position: Lenders will evaluate your current financial standing when you refinance. It’s wise to examine your credit history and credit score to ascertain if you qualify for the most competitive mortgage rates. Estimate your home equity by comparing your home’s current market value with the remaining balance on your mortgage. If you possess a strong credit score and at least 20% equity in your home, you might qualify for a superior mortgage rate and potentially avoid paying mortgage insurance on your new loan. If your aim is to take cash out, you typically need at least 15% (or more) in home equity to do so.
- Select a Lender: When refinancing your mortgage, you are not obligated to remain with your existing lender. It’s often beneficial to engage with several mortgage lenders to inquire about their programs and rates. If you have an established banking relationship with a particular lender, you might be eligible for a discount. Your chosen lender should furnish you with a Loan Estimate that details your anticipated costs and your new monthly mortgage payment.
- Assemble Documents and Secure Your Rate: Just as you did for your current mortgage, you’ll need to provide documentation of your income and assets for the loan application. Your lender will specify the exact documents required, but generally, you’ll need to grant access to bank statements, tax returns, and pay stubs. Once your loan is approved, it’s advisable to lock in your mortgage rate to ensure the rate doesn’t change before your loan officially closes.
- Undergoing Underwriting and Home Appraisal: Maintain close communication with your lender during the review of your loan application, in case additional information is needed. The underwriting process typically necessitates an appraisal of your home. Before the appraiser arrives, make sure your home is tidy and that any minor repairs have been addressed to demonstrate consistent maintenance.
- Finalize Your New Loan at Closing: Upon loan approval, your lender will send you a Closing Disclosure. You should meticulously compare this Closing Disclosure with your initial Loan Estimate. Do not hesitate to ask questions about any discrepancies or anything you don’t fully comprehend. The Closing Disclosure will include all closing costs and instructions for the loan settlement.
The Advantages and Disadvantages of Mortgage Refinancing
While there are compelling reasons to consider refinancing, it’s important to remember that it isn’t always the ideal solution. Before incurring the expenses of a refinance, carefully evaluate how long you plan to remain in your home and your other financial objectives. It may be beneficial to consult with a financial advisor to ensure you fully grasp the implications of refinancing your mortgage.
Benefits of Mortgage Refinancing:
- A reduced interest rate can significantly lower the overall interest expense on your loan.
- Refinancing has the potential to decrease your monthly mortgage payment.
- You might be able to convert an adjustable-rate mortgage (ARM) into a fixed-rate loan, providing greater predictability in your payments.
- Refinancing can potentially supply cash for home improvements, debt consolidation, or other substantial expenses.
- A refinance can shorten your loan repayment term, accelerating equity building and the payoff of your loan.
- If you have sufficient equity, refinancing can be utilized to remove private mortgage insurance (PMI) from your monthly payments.
Drawbacks of Mortgage Refinancing:
- You could end up paying more in total interest over the loan’s lifetime, particularly if you restart your loan with another 30-year term.
- If you opt for a cash-out refinance, your home equity will decrease.
- Should you shorten your loan term, your monthly mortgage payment might increase, unless your new loan balance or interest rate is substantially lower.
- Closing costs, typically 2% to 5% of the loan amount, can either add to your monthly payments (if rolled in) or reduce your available cash (if paid out-of-pocket). Calculate your break-even point—how long it will take for your savings on the new loan to offset these costs—to determine if the refinance expense is worthwhile.
- If interest rates decline further after you refinance, you’ll need to refinance again to take advantage of those even lower rates.
- Your credit score could temporarily decrease due to the hard inquiry on your credit report from a new mortgage application.
- Market conditions can shift, leading to potential regret if you extract too much equity from your home and its value declines in the future.
The Costs Associated with Refinancing a Mortgage
If you conclude that mortgage refinancing is appropriate for your situation, be aware that the process involves various costs. Just like when you initially secured your mortgage, a new home loan comes with its own set of fees and expenses.
Costs commonly associated with refinancing a mortgage might include:
- Application fees
- Appraisal fees
- Credit check fees
- Attorney’s fees (if required in your state)
- Title search and insurance (if mandated by your lender)
- Origination fees (the charges a lender levies for processing a loan)
In certain circumstances, a lender may permit you to roll these refinancing costs into your new mortgage amount.
Homeownership can be both challenging and immensely rewarding. To help you navigate this journey and take command of your finances, City National has developed dedicated resources. We invite you to explore our homeownership resource center today to learn more about the responsibilities and benefits of being a homeowner.