Refinancing Your Mortgage: What It Is and How It Works
A home refinance, often abbreviated as a "refi," is when you replace your existing mortgage with a new one, either with your current lender or a new financial institution. Refinancing your mortgage is a strategic move that can have various benefits, depending on your unique circumstances and financial goals.
Why Consider Refinancing Your Mortgage?
People refinance for different reasons, including:
1. Lowering Your Mortgage Payment
One of the most common motivations for refinancing is to secure a lower monthly mortgage payment. This can free up funds for other important expenses or savings goals.
2. Shortening the Loan Term
Some homeowners aim to pay off their mortgage faster by refinancing into a loan with a shorter term. While monthly payments may be higher, the overall interest paid over the life of the loan can be significantly reduced.
3. Debt Consolidation
Refinancing allows you to roll high-interest debts, such as credit card balances or personal loans, into your mortgage. This can result in a lower overall interest rate and a single, more manageable monthly payment.
4. Removing Private Mortgage Insurance (PMI)
If your original down payment was less than 20% of the home's value, you may have been required to pay for private mortgage insurance. A refinance can be an opportunity to remove this extra cost.
5. Lowering the Interest Rate
Market conditions change, and you might be able to secure a lower interest rate with a refinance. This can lead to substantial savings over the life of the loan. See example here.
6. Changing Loan Programs
Refinancing also offers the chance to switch from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage, or vice versa, depending on your preference and financial goals.
7. Adding or Removing Co-Signers
Life circumstances change, and refinancing provides an opportunity to adjust the individuals responsible for the loan. This is especially common after divorce.
Types of Refinance Loans
Understanding the different types of refinance loans is crucial in determining which one aligns with your specific goals:
1. Rate-and-Term Refinance
This type of refinance focuses on adjusting the interest rate, term length, or both, without significantly altering the loan balance. It's often chosen to secure a lower interest rate or shorten the loan term.
2. Cash-Out Refinance
A cash-out refinance allows you to tap into your home's equity by borrowing more than you owe and receiving the excess funds in cash. This can be used for various purposes, such as home improvements, debt consolidation, or other financial needs.
3. Renovation Refinance
Also known as a renovation loan, this option allows you to finance both the purchase or refinance of a home and the cost of repairs or renovations into a single mortgage.
4. Streamline Refinance
Streamline refinances are specific to government-backed loans like FHA, VA, and USDA. They're designed to simplify and expedite the refinancing process by requiring minimal documentation.
Qualifications for Refinancing Your Mortgage
Several factors come into play when determining eligibility for a refinance:
Current Loan Type: Whether you have an FHA, Conventional, VA, or USDA loan will influence your refinance options.
Loan-to-Value Ratio (LTV): This is the comparison between your home's value and your current loan balance. A higher LTV may impact your ability to refinance.
Mortgage Insurance: Depending on your original loan type, you may have private mortgage insurance (PMI) or other forms of insurance. This can affect your refinance options.
Credit Score: A higher credit score often leads to more favorable refinance terms. However, lower credit scores don't necessarily disqualify you from refinancing.
Debt-to-Income Ratio (DTI): Lenders assess your DTI to ensure you have the financial capacity to handle the new loan.
Impact of Refinancing to a Lower Rate
Here is an example to show how refinancing to a 1% lower rate could affect your monthly payment. This example is for a $600,000 purchase price and a 5% down payment.
*Note: refinancing is not free. While your payment may go down, always consider your closing costs.
Principal + Interest Payment
What to Know Before You Refinance
1.What Type Of Loan Do You Currently Have?
Is your loan a 30-year fixed-rate mortgage or an Adjustable Rate Mortgage? Is your loan conforming, jumbo, FHA or any other type of government loan program? From here, we can figure out which loan program might be most advantageous for you to proceed with. For example, if you currently have a VA loan, it's recommended for you to stick with the same program.
2. How long have you had the loan?
It’s essential to figure out how far into the term of your loan you are so that you may analyze which loan program, interest rate, and term will best benefit you moving forward.
3. What is the current outstanding balance on your loan?
Obtain a copy of your most recent mortgage statement and look at how much you still owe. This will help us calculate your LTV.
4. What is your current interest rate?
If you’re not sure what your current rate is, you can usually find this information on a copy of your most recent mortgage statement.
What documents do you need to provide when refinancing your mortgage?
2 most recent pay stubs
2 years most recent w2 forms
2 years most recent tax returns
Credit Information & Proof of Identity:
Most recent mortgage statement
Copy of Driver's license
2 months bank statements
2 months retirement or investment accounts (if applicable)
Most recent mortgage statement
Homeowners insurance declarations page
Name and contact of HOA representative (if applicable)
Property tax bill
Business Income (if self-employed)
Business license and 2 years federal tax returns if filing Schedule C
Previous 2 years business tax returns
Rental Information (if applicable)
1040s including Schedule E
Copy of mortgage statement for all properties owned
Copy of taxes and insurance for all properties owned
What does it cost to refinance your mortgage?
Mortgage refinancing costs typically fall between 2% and 5% of the total loan amount. The total cost of refinancing can fluctuate based on a variety of factors, such as the size of your loan, the lender you’re working with, the area where you live, your credit score, the amount of home equity you have, and the term of your loan.
The fees will include:
Lender fees such as discount points and underwriting fees
Miscellaneous fees such as appraisal, credit report, notary, recording, etc.
Prepaid fees for hazard insurance and property tax
You have the option to pay your closing costs out of pocket, however many people choose to roll them into the loan amount or opt for a slightly higher interest rate in exchange for a lender credit to cover their closing costs.
What are the steps in the refinance process?
Refinancing your home is a bit simpler than when you purchased it because there are no realtors and negotiations involved. However, there are still a few steps to the loan process:
Shop for your interest rate/terms to ensure you are getting the best deal.
Have your loan officer lock your rate and submit your file to underwriting.
Go through the approval process, including further conditions from the underwriter, title reports, etc.
Once your loan is approved, escrow will be in touch with a notary to schedule signing. Once your final loan docs are signed, your loan will be funded and you will officially have a new mortgage on your home.
When is the right time to refinance?
The best time to refinance really depends on your situation. Factors like your individual circumstances, current mortgage rates, and your financial situation, should inform your decision. If your current mortgage rate exceeds the current market average or you want to tap into the equity of your home, it may be a good time to refinance. On the other hand if you are going through a divorce, you may be in a position where you choose to refinance to remove someone from the loan, even if interest rates are higher at the time. It's also important to consider your financial situation, debt, and credit score at the time. Always consider the impact a new loan may have in the long-term before you apply with a lender.
Are you interested in learning more about your refinance options? Reach out to Castle Funding for a free consult.