Guide to Refinancing a Home Loan

If you’ve heard people talking about refinancing a home loan, you might wonder why and what the process entails. Essentially, when you refinance a mortgage, you replace your original home loan with a new one. Doing so can enable you to tap equity or save money—but not without its own set of risks.

We’ll explain how to refinance a mortgage, including the various steps you’ll need to take in order to obtain a new home loan. Before that, though, let’s go over some refinancing basics, as well as reasons for why you might take this route and the red flags you should watch out for along the way.

• What is a mortgage refinance?
• Types of refinancing
• Reasons to refinance your mortgage
• Steps to take when trying to refinance a home
• Mortgage refinancing mistakes

What is a mortgage refinance?

A mortgage refinance occurs when a homeowner takes out a new loan to pay off the current loan that was used to finance their home purchase. Let’s run the numbers on an example mortgage to see what a refinanced home loan might look like:

Property Value – $250,000; Loan Amount – $230,000

Original Loan

• Term: 30 years
• Interest rate: 4.5%
• Monthly payment: $1,492.00
• Total interest paid: $156,560

Refinanced Loan

• Term: 15 years
• Interest rate: 3.5%
• Monthly payment: $1,876.00
• Total interest paid: $66,235

These are just ballpark figures  given as an example, but as you can see, this homeowner might be able to save themselves tens of thousands of dollars in total interest paid over the lifespan of the loan by refinancing a mortgage into a 15-year term, with only a moderate increase to their monthly payment.

This is only one type of mortgage refinance; let’s go over the different structures in the section below.

Types of refinancing

Typically, there are three different refinancing goals to consider. Each has its own set of pros and cons; here’s what you need to know.

● Rate-and-Term Refinance Loan

The example of mortgage refinancing we looked at above is considered a “rate-and-term refinance loan”. The goal of this type of refinance is, as the name implies, to change the interest rate and/or repayment term of a home loan without adjusting the amount of the loan.

Shortening the repayment term of a mortgage loan usually qualifies borrowers for lower interest rates, saving you tons of money in interest. Alternatively, lengthening the loan term can make monthly payments smaller and paying down your mortgage more affordable, but borrowers will have to pay more in interest in the long run.

● Cash-Out Refinance Loan

Refinancing a home with a “cash-out loan” involves cashing out a portion of the equity accumulated in the property, providing homeowners with money they need for certain activities such as affording a large purchase, paying off debt, or buying out a spouse in a divorce.

where did these figures come from if they are “ballpark”.  Could you find more concrete examples?

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Doing so typically results in a higher loan amount (with the difference usually equal to the portion of equity accessed), as well as higher interest rates and monthly payments compared to a rate-and-term refinance home loan.

● Cash-In Refinance Loan

Although less common, a “cash-in refinance” happens when a homeowner brings money to the table to lower their existing mortgage balance. This might take place when a borrower is underwater on their mortgage and needs to lower their loan-to-value ratio (LTV) to an acceptable threshold, but it may also be used to avoid mortgage insurance or obtain a lower interest rate.

Reasons to refinance your mortgage

There are many reasons to refinance a mortgage, which will depend on the goal you’re trying to accomplish. Below, are the top five reasons why people refinance a home loan to give you a better understanding of why you might want to do the same—including which type of refinancing you should consider to get the job done.

1. Reduce monthly payments

If you’re hoping to owe less on your monthly mortgage payment, you may be able to qualify for a refinance home loan with a lower interest rate by improving your credit score. You can also extend the mortgage repayment term—say from 15 years to 30 years—to give yourself more time to pay off the principal balance in smaller increments.

2. Tap into equity

A cash-out refinance mortgage allows you to borrow more than what you currently owe on your home loan and pocket the difference. Many homeowners use this strategy to finance home improvements, pay for education, or make a large purchase. You may be able to take cash out of your home if you’ve been paying on the loan long enough to build equity or if the property value has increased, since a higher value means that a lender can give you more money to finance it.

Note: According to Debt.org, a Home Equity Line of Credit (HELOC) offers homeowners another way to tap into their equity and cover expenses, without the need to alter the existing mortgage—so you should always be sure to research all of your options to find the best fit for your needs.

3. Pay off another loan

When you obtain a cash-out refinance loan, you can also use the funds to pay off high-interest credit card bills or student loan debt. Mortgage interest rates tend to be considerably lower than other types of loans, plus the payments are tax-deductible (up to certain limits) whereas others are not; therefore, refinancing a mortgage could be a way to consolidate and pay off debt.

4. Eliminate FHA insurance

Borrowers can eventually eliminate the private mortgage insurance paid on conventional loans once the principal loan balance falls below a certain threshold, but borrowers who obtain mortgages serviced by the Federal Housing Administration (FHA) are typically required to pay FHA mortgage insurance premiums for the entire lifespan of the loan; the only way to eliminate these payments is by refinancing the mortgage once enough equity is accumulated.

5. Switch to a fixed interest rate

Finally, the interest rates on an adjustable-rate mortgage (ARM) tend to increase over time and are prone to sudden spikes, although they usually appear attractive at the initial time of close. This can make budgeting difficult and unpredictable compared to the financial stability provided by a fixed-rate mortgage that stays the same every month for the life of the loan.

Currently, the average interest rate on a 30-year, fixed-rate mortgage is 3.7% (compared to 4.27% this time last year), which homeowners may be able to access by refinancing their home loan.

Steps to take when trying to refinance a home

If you’ve decided that refinancing is in your best interest, then these are the steps you’ll need to take when learning how to refinance a mortgage.

1. Determine goals

First, decide what you want to get out of a mortgage refinance, then use your established goals to guide you through every part of the process. For example, rather than applying for bridge loans to cover the cost of a short-term investment, you may be able to tap into equity and use the funds to cover the same costs—without the need to put down collateral in the process.

2. Check your credit

In order to qualify for the lowest interest rate possible, you’ll want to take the time to improve your credit score. However, if market rates have increased substantially since obtaining your first loan, a better credit score may not necessarily earn you a lower interest rate when refinancing a mortgage—in that case, it may be better to wait until rates drop back down before refinancing.

3. Shop around

Not all lenders are the same, and refinance rates will vary. Make some phone calls and shop around by asking for a Loan Estimate from each potential lender, or a three-page document that outlines the loan’s terms, projected payments, estimated closing costs, and other various fees. Then compare each one to identify the best solution for your needs.

4. Submit application

Prepare your financial documents before submitting your application so your refinance loan can close quickly. The lender will likely ask for your two most recent W2’s, pay stubs, and/or bank statements to determine your debt-to-income ratio, as well as any other co-borrower listed on the mortgage refinance. If you’re self-employed, you may have to provide additional information to verify your income.

5. Wait to close

Once you submit your application, you may need to wait a while for the loan to close while a lawyer settles the original loan and redeems your property; the process could take up to a couple of months to complete, unless you run into any refinance problems such as an erroneous appraisal that sets the timeline back.

At this stage, you should be prepared to pay closing costs, such as application and appraisal fees, once your application is processed—which may still be due even if your loan is denied.

Mortgage refinancing mistakes

Underestimating the closing costs involved with refinancing a mortgage is one of the biggest mistakes borrowers can make, along with overestimating the market value of the property. USA.gov provides consumers with additional resources on refinanced mortgages and warns of “predatory loans” that may try to take advantage of unsuspecting homeowners with unfair terms, prepayment penalties, and so forth.

Ultimately, the risk in refinanced mortgages lies in ignorance, because without the right knowledge guiding your refinancing decisions, you can actually hurt yourself with higher interest rates and monthly payments—as well as an increased principal balance that may seem impossible to pay off.

Wrapping Up

A mortgage refinance may make a lot of sense for your financial circumstances, but be sure the savings will outweigh the closing costs. It could be a great time to take advantage of falling interest rates, so long as you do your own legwork and compare refinance rates to find the best deal in town. Before pulling the trigger, remember to monitor your credit score with Mint, as great credit can help you secure a better refinance loan package.