Refinancing saves Americans thousands of dollars yearly. According to a FreddieMac report, homeowners took advantage of the low-interest rates in the first half of 2021, saving over $2,800 in mortgage payments annually.
Imagine what you could do with the additional funds you save on your monthly payments.
Refinancing is a smart financial strategy every homeowner should learn about.
In today’s posts, we’ll explore the following:
- The definition of mortgage refinance;
- Why and when it makes good money sense;
- How it works;
- And how to get the best rates and savings out of the process.
Let’s get started.
I | What is mortgage refinancing?
Refinancing replaces your current home mortgage loan with a new one.
Homeowners refinance to take advantage of lower interest rates, shorter terms, monthly savings on premiums, or gain access to their home’s equity.
Refinancing can help you swap your current mortgage type for another.
For example, moving from an adjustable-rate mortgage to a fixed-rate mortgage. Or eliminating mandatory FHA mortgage insurance by switching to a conventional loan.
The reasons behind the move complement your financial objective. Whether you want to repay the loan faster, get money for a new home, or do home repairs. We’ll explore your refinance options later in the article, but first, let’s look at how it works.
II | When Does Refinancing Make Good Money Sense?
Refinancing your mortgage may seem simple, but there are many factors to weigh when debating whether to go through the process.
Debt Management
Consider your current situation. If you’re behind on debt repayment, you might want to start paying down your debts before considering refinancing.
Your credit report reflects all of your accumulated debt and current repayment records. Lenders check borrowers’ credit history to determine who poses the least risk of defaulting on payments.
Refinancing before clearing up your present credit obligations might not be your best choice if your credit is in the red. For one, you’ll likely miss out on low-interest rates, and the chance of the lender declining your application is higher.
The Home’s Equity
The more equity you have in your home, the better. Both for you and your lender.
Equity of at least 20% increases your favor with lenders. As a result, they’ll offer you better rates, and you’ll pay fewer fees. Your equity will also qualify you for better loan options.
Calculate your home’s equity by subtracting your outstanding loan balance from the total value of your home. If the result is 20% or more, you’re in good standing for favorable terms on your new loan.
Saving is Not Guaranteed
Not everyone saves when they refinance. Use a mortgage refinance calculator to check how much you could potentially save. Suppose the current interest rates aren’t at least half a percent lower than your original mortgage. In that case, it doesn’t make good money sense to refinance.
Likewise, if you’re struggling with debt or your home’s equity isn’t at 20%.
>> For more information how the benefits of refinancing and the pitfalls, check out: Things to Know Before Refinancing Your Mortgage.
III | How to Refinance Your Mortgage
Step 1: Shop for the Best Refinance Rates
Explore the current rates on the market. You don’t have to stick with your present lender if you can find a more beneficial deal from another. Your new lender will pay off the current loan, ending your relationship with your old lender.
Screen your options with a critical eye. The slightest difference in mortgage rates can save or cost you thousands of dollars.
Along with rates, check for competitive repayment terms and client reviews. Customer care service is part of the experience.
Step 2: Start the Application Process
When you apply to refinance, lenders check your assets, income, debt-to-income ratio (DTI), and credit score. All the information you supplied for your original mortgage.
Prepare the necessary documents for submission along with your application. Providing incomplete documentation will slow up the underwriting process.
Here are some of the documents you’ll need for a mortgage refinance:
Proof of Income
Lenders will check if you make enough money to handle the new refinance loan on top of your other debts and regular living expenses.
Income documentation includes recent pay stubs, bank statements, W-2 forms, and tax information. They usually ask for the two or three most recent copies.
Self-employed applicants will need tax return documents, recent bank statements, a breakdown of their loss and profit, a list of business debts, and possibly a cash flow analysis Form 1084.
Check with the lender to ensure you have all the necessary documents.
Proof of Assets
Along with proving your earnings, you need proof of your assets. These assets can be physical property or cash reserves.
Lenders are looking for surplus funds you can use in a financial emergency to meet all of your financial obligations.
Home Insurance Information
Your home insurance policy acts as proof of ownership. It also proves you have active coverage protection on the property.
The lender might order an appraisal of the home to verify its value. If the property value has appreciated since you bought your coverage, the lender may require that you increase your coverage limit.
In the event of a named disaster, the insurance protects their investment.
Ensure you have a copy of your title insurance as well. Lenders require borrowers to purchase title insurance before obtaining a home loan. If you misplaced your copy, contact the title company for a new one.
Credit Report
The lender will carry out a credit inquiry to verify your credit standing. The report outlines how you manage debt and damaging credit events like late payments and defaults. Credit agencies summarize all this information into your credit score.
If you have any negative credit events, lenders may ask for an explanation for why they happened.
A healthy credit score increases your favorability with lenders who deem you a safe investment.
Debt Statements
A lender will request copies of your most recent statements if you have any outstanding debt. Your credit report lists all these debts, so the lender will know if you withhold any information.
The balances on the accounts will go into calculating your debt-to-income ratio.
Explore all of your options.
Take note of the eligibility requirements of each mortgage lender in your research. You may encounter one with an affordable rate, but you don’t meet all of their standards. Your credit score will be an essential basic requirement.
Apply for a loan from three to five lenders. Once they respond, you can compare the loan estimates and choose the most advantageous option.
Send your applications within a two-week period. Working within this timeframe will lessen the impact on your credit when the lenders do their checks.
Step 3: Lock Your Interest Rate
After your loan approval, lock your interest rate. Locking your rate ensures it won’t change during the specified rate lock period before the loan closes.
Rate locks typically last for about 30 to 60 days. It all depends on the lender, your location, and the type of loan you’re processing. An extension will cost you money if you can’t close the loan before the rate lock period expires.
Step 4: The Underwriting Process
Once a lender receives your application, they’ll begin the underwriting process. At this stage, they’ll verify all the information you provided in your application.
Underwriting can take a few days or weeks. The time depends on:
- The amount of financial information the underwriter has to process and verify;
- And whether they have all the documents they need to complete underwriting your new loan.
The fewer speed bumps they encounter, the faster the process.
Step 5: Prepare for a Home Appraisal
Underwriting includes an appraisal report estimating your home’s value. The results of your refinance appraisal will decide your refinancing options.
Prepare your home and make sure it’s in the best shape possible.
Clean up the home’s exterior and interior. Make a list of all the improvements and upgrades you’ve made. Increasing your property’s curb appeal and renovations increase your home’s value.
The higher the value/equity, the more you can borrow in cash-out mortgage refinance. You can also remove mortgage insurance premiums with 20% equity or more and lower your monthly mortgage payment.
The lender will include the appraisal fee as part of the closing costs for the loan.
Step 6: Close on Your New Loan
Once your refinance appraisal and underwriting are complete, it’s time for closing.
You’ll receive a ‘Closing Disclosure‘ from your lender with the final tally of your loan. It shows the loan amount, the interest, and the cost of fees.
Review all the information in the document. Ask about prepayment penalties and look out for hidden charges before paying closing costs and sealing the deal.
You have a 3-day grace period from closing the deal to cancel your contract. If you applied for cash-out mortgage refinancing, expect the delivery of your funds after the grace period passes.
IV | Refinance FAQ
What’s the difference between refinancing and cash-out refinance?
With a standard rate-and-term refinance, you exchange your current loan for one with better terms. You can switch from a 30-year loan to a 15 or 20-year mortgage to repay your loan faster. Or swap an adjustable for a fixed-rate mortgage to lock in a low-interest rate.
Cash-out refinancing grants you access to your home’s equity through a loan. It increases your mortgage with a higher interest rate, added fees, and points. Qualifying for a cash-out option requires a higher credit score than a rate-and-term refinance.
Refinancing will affect your credit score, but it can bounce back in a few months.
How often can you refinance conventional home loans?
There isn’t a set limit on how often you can refinance your mortgage. Lenders will have a waiting period starting from the date of closing, but those aren’t very restrictive. Most last for about six months.
The new lender might be willing to overlook the waiting period if you move from one lender to another.
Time restraints vary for government-issued loans, with wait periods of up to 210 days.
Conclusion
Refinancing is not for everyone. Weigh the pros and cons against the potential savings and your debt reduction.
- Shop for the best mortgage interest rates on the market.
- Start the application process with all of the necessary paperwork. Submitting the proper documents with the correct information can streamline the underwriting process.
- Lock your interest rate to avoid a spontaneous increase during processing.
- Prepare for a home appraisal. The benefits of your refinancing hinge on the value of your home.
- Close on your loan only after you’ve read and understood your Closing Disclosure agreement. You have three (3) days to cancel the contract after signing.
