Guide to Mortgage Refinancing
If you have a mortgage, there's a good chance you'll refinance it at some point. Few borrowers stay with their original home loan for a full 30 years; most either refinance or sell the property long before the full term runs its course.
A mortgage refinance is simply replacing your old mortgage with a new one that offers better terms. Your new lender pays off your old mortgage, and from then on the new lender holds the mortgage on your home. The loan requirements and the process you go through when you refinance a home loan are much the same as they are for a home purchase mortgage.
Why refinance your mortgage?
People refinance home loans for a variety of reasons. Some of the main ones are:
To get a lower rate:
If interest rates have fallen or your credit has improved since you first took out your mortgage, refinance mortgage rates may be lower than the rate you're paying now. This can reduce your monthly payments.
To pay it off faster
A home refinance to a shorter term can help you pay off your loan more quickly. For example, if you've had a 30-year mortgage for some time, you might refinance the remaining balance into a 15-year loan instead. Because short-term mortgages have lower refinance rates than longer ones do, this often means you can pay off your loan several years faster with little or no increase in monthly payments.
To borrow money
You can borrow money through a cash-out refinance. Let's say your property is worth $250,000 and you owe $100,000 on your mortgage. You might do a home refinance for a new mortgage of $150,000 and receive $50,000 in cash. It's really a type of home equity loan. This works particularly well if you can also lower your mortgage rate at the same time.
To consolidate debt
A cash-out refinance can be used to consolidate debt. You simply use the proceeds to pay off credit cards and other high-interest loans. Your refinance rate will likely be lower than the rates you were paying and you get to consolidate your bills into a single monthly mortgage payment. And mortgage interest is usually tax-deductible as well.
To change mortgage types
People may do a home refinance to exchange an adjustable-rate mortgage (ARM) for a fixed-rate one. This may be because their ARM is about to start readjusting and they want to lock in a predictable rate, or to avoid having to make a balloon payment. Or they might refinance out of an FHA loan once they have enough home equity to avoid paying for mortgage insurance.
Qualifying to refinance
Qualification guidelines to refinance a home loan are pretty much the same as they are for a mortgage to buy a home. Credit and income requirements are practically identical and the home must still appraise for enough to support the loan. Your home equity replaces the down payment you'd make when purchasing.
Credit score requirements vary from lender to lender but have loosened considerably in recent years. It's now often possible to do a mortgage refinance with bad credit; many lenders will approve refinancing for borrowers with scores of 620 or lower. Some lenders will approve refinancing into an FHA loan for those with credit scores in the mid-500s.
On income, your new mortgage payments, including taxes and insurance, should not exceed 28 percent of your monthly income, and total debt payments should be no higher than 41 percent. Lenders may go above these limits for borrowers with excellent credit, however.
You generally want to have at least 20 percent home equity to refinance a home loan. Lenders may go lower than that, but you'll have to pay for mortgage insurance, the same as you would when buying a home with less than 20 percent down.
If you have little or no home equity, there are still options available to you. An FHA Streamline refinance allows those who currently have an FHA mortgage to refinance into a new one without a property appraisal. Income and credit requirements may be waived as well. A similar streamline refinance option is available to VA borrowers.
Low or negative-equity homeowners with conventional mortgages (those backed by Fannie Mae or Freddie Mac) can refinance through HARP, a federal program. HARP is scheduled to be replaced by a streamline refinance option in Fall 2017.
What does it cost to refinance?
Home refinance costs are about the same as those for a purchase mortgage, except that you don't have the real estate fees associated with transferring the ownership of the home.
Expect to pay about 2-6 percent of the mortgage amount when refinancing. Costs at the high end of this range are associated with paying for multiple discount points, which are a way of buying a lower refinance rate and cost 1 percent of the loan amount per point. Costs will also vary depending on where you live, with some areas charging higher recording fees and taxes.
Lenders sometimes advertise what's called a "no cost refinance," one where nearly all closing costs and fees are waived. But they compensate for this by charging higher refinance rates on these loans than they would if the fees were paid separately or rolled into the loan amount. You need to compare the costs over time to see which is the better deal.
Can you refinance a second mortgage?
Sure! You can refinance a home equity loan or other second mortgage the same as you can refinance your primary home loan. The process is largely the same – you take out a new second mortgage that pays off your existing one and gives you a lower rate or better terms.
You can also refinance a second mortgage through a cash-out refinance of your primary home loan. You use the proceeds from refinancing to pay off your second mortgage and simply roll everything into your primary mortgage. That way, you only have a single payment to worry about, and may get a lower interest rate as well.
What about a loan modification vs. refinance?
Refinancing is when you replace your current mortgage with a new one with different terms. A loan modification is changing the terms of your current mortgage to make it more affordable, such as by reducing or rescheduling payments.
Refinancing is considered the better option. Loan modifications are for borrowers in financial difficulty who can't get approved for a refinance. You need your lender's approval for a loan modification, which can be difficult to get. Basically, your lender needs to be convinced they're better off cutting you a little slack on your loan so you don't go into foreclosure.
Should I refinance?
A key factor in deciding whether to refinance is how long it would take you to reach the break-even point. That is, how long would it take for the savings from a lower interest rate to exceed the fees you paid to refinance the loan?
If you can recover your costs in three to four years, you should seriously consider refinancing. But if it will take you seven or eight years to reach your break-even point, proceed with caution. People tend to move about every five years on average, and if sell the home before reaching your break-even point, you'll have lost money. So keep that in mind.
Other reasons to refinance a mortgage may have nothing to do with the break-even point, such as shortening your loan term or switching out of an ARM. Those are often subjective decisions for which there are no hard-and-fast answers. You just have to look at the numbers and decide what makes good financial sense for you.
Where can I refinance?
You can refinance a mortgage with any mortgage lender – you don't have to stay with your current one. A refinance is a new start – you take out a new mortgage, your new lender pays off your old one and you go forward from there.
It's a good idea to shop around to find the lender who will offer you the best refinance mortgage rates and terms. You want to compare offers from at least three different lenders, and perhaps even more.
When shopping around for a refinance lender, you want to do more than just compare refinance rates. You need to take into account the fees and other terms as well. A convenient way to do this is by looking at the APR, which is a way of expressing the total cost of a loan in terms of an interest rate. It's a good place to start but isn't 100 percent accurate, particularly if you expect to sell the home or refinance again in a few years.
Most lenders allow you to shop for a mortgage online these days, which makes it easy to obtain and compare rate quotes from multiple lenders. Many can even do the entire application process online as well, which can greatly simplify the process – you can submit your documentation, receive updates, get and respond to requests for additional information – the works. The lender doesn't even need to have an office in your community –the closing is often handled at the office of an attorney or title company.
A convenient way to get started is by submitting a request for personalized rate quotes using the form at the top of this page. You'll quickly receive quotes for refinance rates from up to three lenders tailored to your personal situation, allowing you to easily compare offers in real time and see which one is best for you.