What Is Mortgage Refinancing & How Does Refinancing Work?
What Is Mortgage Refinancing & How Does Refinancing Work?
Refinancing mortgage rates sounds as simple as paying off an existing loan and replacing it with a new one. Unfortunately, the mortgage refinance process can be more than a little intimidating, and making mistakes can cost you thousands and undermine your financial goals.
However, refinancing a mortgage can be a great move in many situations. It's important to understand the unique position of you and your home, your financial goals, and what a successful refinance would look like to you. If you're asking, "Should I refinance my mortgage?", you're in the right place. To help you decide if a refinance is right for you, and help avoid common mistakes, we've pulled together some key refinancing tips below.
What Does it Mean to Refinance a Home?
When you take out your original mortgage, it is to finance the purchase of your new home. So it makes sense that to "refinance" a home would be to replace that existing mortgage with a new one.
So far, so good–but why do people usually refinance their mortgages in the first place?
- Lower interest rate: New mortgage=new terms. One of the most common reasons for refinancing is to secure a new mortgage with a lower interest rate.
- Change loan type: If homeowners have a variable interest rate, they may favor switching to a fixed interest rate to achieve more stability in their future financial planning.
- Cash-out refinance: In a cash-out refinance, homeowners borrow more than the remaining balance of their existing mortgage. The difference is paid out to the homeowner in cash, which they can use to fulfill any financial needs.
- Remove private mortgage insurance (PMI): If a homeowner's home equity has significantly increased, they may refinance to eliminate the need for private mortgage insurance (PMI), if their original loan required it.
How Does Refinancing Work?
Assess Your Current Financial Situation
Familiarize yourself with your credit score, calculate your home equity, and determine your financial goals.
Shop Around for the Best Mortgage Lenders
The world of mortgages is fiercely competitive, and it's a major opportunity for you to find the lowest fees and best rates.
Gather Necessary Documentation
You’ll need documentation for a refinance, such as pay stubs, tax returns, and bank statements.
Apply to Refinance Mortgage
Once you've identified a lender, you'll apply for the new mortgage.
Lock in Your Refinance Mortgage & Interest Rates
Select the loan term and the type of interest, whether fixed or variable.
Submit Your Paperwork for Underwriting
The underwriters will determine your creditworthiness.
Schedule a Home Appraisal
The lender will usually order an appraisal of your property to determine its current market value.
Close Your New Home Loan
If your application is approved, you'll sign the new loan agreement and other required documents.
Pay Off the Existing Loan
You will use the funds from your new mortgage to pay off your existing mortgage.
Reasons to Refinance Your Home
- Change Your Loan Term
- Lower Your Interest Rate
- Change Your Loan Type
- Cash Out Your Equity
Reasons Not to Refinance Your Home
- Impact on Credit: Missing mortgage payments during the refinancing process can negatively impact your credit.
- Added Interest: Extending the term of your mortgage can lower your monthly payments but increase your total interest paid.
- Extended Loan Term: If you've paid down a significant portion, refinancing may not be cost-effective.
- Closing Costs & Fees: Refinancing can involve substantial closing costs.
Mortgage Financing FAQs
What does it cost to refinance a mortgage?
Make sure you fully understand the closing costs associated with each loan. The Estimated Closing Costs show how much the lender is charging you for the refinance.
When should I refinance my mortgage?
Consider refinancing if market interest rates have dropped significantly or if your credit score has improved.
What’s the difference between a second mortgage and refinancing?
A second mortgage is a separate loan while refinancing involves replacing your existing mortgage with a new one.
What are the types of mortgage refinancing?
- Rate-and-Term Refinance: Change the interest rate and/or the loan term.
- Cash-Out Refinance: Borrow more than the outstanding mortgage balance and receive cash.
- Cash-In Refinance: Pay down a portion of your mortgage balance at the time of refinance.
- Streamline Refinance: Available for FHA and VA loans with reduced underwriting requirements.
- Rate-and-Term Refinance with Cash-In: Change the interest rate while also making a cash payment to reduce your loan balance.
- Consolidation Refinance: Consolidate multiple loans into a single mortgage.
Can I tap into my home equity without refinancing?
Yes, options like Unison equity sharing agreements allow you to access your home's value with no monthly payments.