If you’re a homeowner with a mortgage, then you’ve certainly heard that mortgage rates are reaching historic lows during the pandemic. In fact, it’s one of the reasons that there’s been an unprecedented demand for new and existing homes since the spring of 2020.
However, these same ultra-low mortgage rates are also responsible for the extremely high demand for home mortgage refinancing. In order to take advantage of these historic low rates, homeowners need to understand how to refinance their mortgage.
What is mortgage refinancing
A home mortgage is a loan that is taken to pay for the borrower’s property. Most of these loans have a duration of 30 years, with 15 year loans also being somewhat common. Since most home mortgages don’t have a penalty for early payoff, homeowners have the opportunity to save money by paying their existing mortgage, in the process of taking out a new one with a lower rate, or better terms than their old mortgage. Or, you can refinance your mortgage in order to access equity in the property. Home equity is the value of a property, after any outstanding loans have been paid off.
How does refinancing work?
When an existing homeowner wishes to refinance their property, the new loan is used to pay off the old loan. The lien of the old lender is satisfied and removed from the property record, the lien for the new mortgage is added. If the homeowner has a second mortgage, or any other liens on the property, these too must first be paid off by the homeowner or as part of the refinance process. With a mortgage refinance, the new loan must be large enough to pay off all existing mortgages, any additional money borrowed can be retained by the homeowner. When additional funds are remaining, this is referred to as a cash-out refinance.
How to refinance your mortgage
Step 1: Shopping for a new mortgage
Just as with your original home mortgage, there’s a process to be completed for refinance. That process begins with the homeowner shopping for a new mortgage. You could start by asking for the currently available rates and terms from your current lender, and it also makes sense to enquire with other banks or credit unions that you already have a relationship with. Other ways to shop for a mortgage refinance include working with a mortgage broker, who will be able to shop around for rates from dozens of other lenders.
You also want to consider what kind of loan you want to refinance with. Your options will include loans with various terms, fixed or adjustable rates and options to buy down the rate by paying a larger amount up-front.
Finally, consider if you want a loan far above your current outstanding balance, in order to take cash out. Alternatively, you could request a loan for less than the amount of your current balance, and put cash in. This can be attractive if doing so allows you to qualify for a conforming loan, rather than a so-called Jumbo loan that exceeds the value that conforms to limits set by the Federal Housing Finance Agency (FHFA).
Step 2: Applying for a loan
Once you’ve selected a lender and a product, you’ll need to formally apply for the loan. The lender will need several pieces of information from you, including proof of employment or income. This can come in the form of your most recent pay stubs, or a letter from your employer confirming your position and salary. If you’re a business owner, then you’ll need to provide your two most recent annual tax returns, and possibly profit and loss statements from the current year.
You should also expect to show them the most recent statement from your current mortgage, and any second mortgages or other liens. Some lenders may also ask for documentation of other loans such as auto loans and student loans. You may also be asked to document your assets such as stocks, bonds and other investment savings.
Other required documentation can include your most recent tax returns, including 1099s and W-2’s. The lender will also ask for your permission to check your credit reports. You should also be prepared to show the lener proof of homeowner’s insurance and title insurance.
Step 3: Getting an appraisal
Once your application is submitted, the lender will likely order an appraisal of your home. In the past an appraisal always meant scheduling an appraiser to visit your home, examine it and verify it’s value. Today, so-called drive by appraisals have become common, which don’t require the appraiser to enter your home.
If the appraisal and the rest of your documentation are satisfactory to the lender, your loan will be approved by the lender’s underwriter or underwriting committee. However, it’s important not to apply for any other loans or lines of credit after you have submitted your application, until the loan has closed. Applying for new lines of credit during this process could be seen as a sign of potential financial problems. And even if that’s not the case, the lender may have to start the process all over again due to changes in your credit history and credit score.
Step 4: Closing on the new loan
The last step of the refinancing process will be to schedule the closing. With a home mortgage refinance, the ownership of the property doesn’t change, but the original lien is paid off and a new lien is registered with the city or county that holds the deed. Nevertheless, you’ll still need to schedule a closing where you sign numerous documents and disclosures. And just as with any other mortgage, you should see a settlement sheet detailing all of the fees charged, and payments you’ll have to make, or credits you’ll receive at closing. In addition to the appraisal fee, you’ll likely have to pay fees for title insurance, document processing and origination fees, just to name a few of the potential charges.
While you should always examine your closing documents, the time to do so is generally not at the closing. In fact, you should have received copies of those documents, typically by email, well before the closing. And according to the Federal Truth in Lending Act (TILA), you have until midnight of the third day after closing, excluding federal holidays and Sundays, to cancel your loan without penalties. This is called the right of rescission.
When should you refinance your mortgage
There’s no simple answer to the question of when you should or should not refinance your mortgage. Many homeowners refinance their mortgage in order to take advantage of lower rates, which has been the general trend since the early 1980’s. If this is why you’re considering refinancing your home, then you need to take into account how much lower the new rate will be compared to the old rate, and how much you’ll save in both payments and interest charges. You could calculate the savings on a monthly basis, over the life of the loan or just over the period of time that you expect to have this loan until you sell the property or refinance it again. If you expect to save enough money that the additional cost and fees are worth it, then it can be a good idea or refinance your mortgage.
Another reason to refinance your mortgage is to take cash out. With a cash-out refinancing loan, your new loan is greater than your old loan, and the lender will give you a check for the difference, minus any fees. This can be an alternative to a second mortgage, also known as a home equity loan or home equity line of credit.
Other reasons to refinance your home could include wanting a lower monthly payment. By taking out a new loan, you will only have to finance the remaining balance, which will be lower than your original loan. And unless mortgage rates have risen substantially, the smaller loan amount will mean a smaller monthly payment.
You could also decide to refinance your home in order to change your product. For example, you might go from a variable rate to fixed rate, from a longer term loan to a shorter term loan or from a jumbo to a conventional loan. In these cases, you still need to calculate any savings you expect and weigh it against the costs of the new loan.
How much does it cost to refinance mortgage
If you could refinance your home mortgage without incurring any costs, then you’d probably want to do so often. But unfortunately, there will always be several costs associated with any refinance of your loan. These costs will vary based on a number of factors including the size of your loan, the lender you go with, your credit history and your available home equity. Other fees you’ll have to expect will include an application fee, a credit report fee, and fees for home appraisals, home inspections, title searches and recording fees.
These fees will always vary based on the location of your home, but the lender should be able to provide you with estimates before you submit your application. Most of these fees will be fixed, with the exception of the origination fee, which is a percentage of the loan amount.
Benefits of refinancing your mortgage
- Taking advantage of lower rates. Home mortgage interest rates are constantly changing, and if you can find a significantly lower rate, it can make sense to refinance your home.
- The ability to take cash out. If you’ve paid off a significant amount of your loan, or your home has appreciated since it was purchased, then you may have the chance to perform a cash-out refinance. And unlike many kinds of loans, you can use the cash for whatever you like. And since interest on a home mortgage is tax deductible (up to a limit), this loan can have favorable tax implications.
- Lower monthly payments. When you refinance your loan for a lower amount than your original loan, you’ll enjoy lower monthly payments.
- Take advantage of improved credit. If you didn’t have excellent credit when you received your mortgage, you would not have received the lowest rates available at that time. But if your credit score has significantly improved
Risks of mortgage refinancing
- Closing costs can eat up all of your savings. You won’t consider refinancing your mortgage unless your monthly payments went down. But at the same time, you have to weigh your savings against the closing costs that you’ll incur. The lower your outstanding balance, the higher the closing costs will be as a percentage of your loan amount. Therefore, as you get closer to paying off your mortgage, there will be less advantage to refinancing it.
- Increasing the loan’s term. Unless you refinance for a much shorter term mortgage, like a 15 year, then you’ll almost certainly be extending your loan’s term. This will extend the date that you will pay off your loan. It will also decrease the amount of principal being paid off every month.
- Moving. A home mortgage refinance makes the most sense when you’re planning on owning your home for many years. But if you move sooner, then your closing costs won’t be spread out over as long of a time, and it might not have been worth it to refinance.
A mortgage is a powerful financial instrument that allows tens of millions of Americans to own their own homes. And one of the beauties of this system is that you usually have the option to update and upgrade your mortgage when lower rates or more favorable terms become available. By learning about how mortgage refinancing works, and choosing the best product for your needs, you can save money while you increase your equity in your home.