Mortgage interest rates have continued to hit new lows while home equity has grown to new highs. These can be the perfect conditions for an attractive home loan refinance.
Now is certainly a good time to consider refinancing your mortgage. If this is the right choice for you, it could be one of the most financial moves you make in your lifetime. It can preserve wealth gains, save many thousands of dollars, and restructure your overall finances in a much more sustainable way.
Continue reading to learn what mortgage refinancing is and the steps to refinancing a home loan.
Applying for a refinance loan has its advantages, but it isn’t always the right time for everyone. There are also different types of loans to consider.
What Is Refinancing?
When someone refinances their home loan, they're swapping the old loan for a new one. The refinance loan pays off the old mortgage, which sounds fantastic, but you still have to pay the new mortgage. Why would anyone do this?
People who apply for a refinance loan want to change the terms of their mortgage, get lump sums of cash or restructure their finances to save money.
Not everyone has the same home loan. Some people have a 30-year loan while others have a 15-year loan. You can choose between an adjustable interest rate or a fixed rate. The amount you pay for closing costs also alters your home loan.
Many people choose to refinance their house to get a lower monthly payment, pay less money in the long run, use their home equity to improve their house or help pay off bills.
Compared to a regular mortgage, there is less paperwork involved and there may be no paperwork in some cases. Usually, lenders look at the applicant's credit score, payment history, income and employment history, retirement assets, and cash reserves.
If you choose a streamlined refinance, it'll take less time to approve your refinance. You may not need to go through income and credit score verification or a home appraisal. In some cases you can even borrow more than your home is worth.
Types of Refinance Loans
There are three types of refinance to choose from. You can apply for a cash-out, limited or ‘no cash-out’, or rate-and-term loan.
A cash-out refinance involves taking out a larger loan to pay off your current loan and capture some of the equity in your home. This loan can either have a shorter term, meaning you pay off the amount in less time, or it can have a lower interest rate.
A cash-out loan is more than $2,000 cash in your pocket, after the new loan is written. This extra money can be spent on anything you like, or just kept in the bank for emergencies.
The requirements are the same but it can be perceived as more difficult to get a cash-out refinance than other types since you have to qualify for more borrowed money.
A limited cash out refinance means you take less than $2,000 or 2% of the loan amount out in cash at the closing. However, you can still increase your loan amount and borrow plenty more cash that is used to directly pay off and consolidate other debts from the closing escrow account. This can include paying off credit cards, student loans, auto loans, personal loans, medical bills and any associated closing costs.
This kind of refinance can give you a shorter term, lower interest rate, lower payment or a combination of all three. You can get lower interest rates with a reduced loan-to-value (LTV). LTV is the ratio of the loan amount to the value of your home.
An LTV of 80% or less will stop your private mortgage insurance (PMI) costs and get you the best rates and terms.
Rate-and-term refinances change the interest rate of the loan or the length of the term. Some people can choose to change both. For example, someone may want to adjust the loan term from 30 years to 15 years and lower the rate to 2.25%
This refinance type is a common choice for people looking to save money in the long-run by eliminating the additional interest that is associated with the 30yr term, as well as immediately lowering monthly housing payments.
In some cases this can save hundreds of thousands of dollars over the life of your loan.
Average interest rates have gone from almost 18% in 1982 to below 3% in 2021. Check out just how high they can go in these charts from Freddie Mac, and in this graph from the federal reserve.
When to Refinance
Although you can apply for a refinance loan at any time, you often save the most money when home loan rates drop, or your home value has gone up.
Once your refinance loan application is already in process with a lender, then you can choose to lock the rate immediately if the rates drop.
If you have an adjustable-rate mortgage (ARM), you may decide to switch to a fixed-rate loan when rates start increasing, by refinancing with a new loan.
With an ARM, rates fluctuate, so you'll pay more per month when rates go up. A fixed-rate mortgage will keep the interest rate the same.
A high credit score means a lower interest rate. Some people refinance their house when they have improved their credit score so they can pay less interest.
Taking out a new mortgage can be an alternative to a home equity loan. If you need money for home repairs or other debts, an increase in your home's value can help.
A higher home value means you can get a larger loan that covers the loan balance on your house and gives you some of the equity in cash if you choose.
A refinance loan can lower your monthly payments, help you pay off your house sooner, and give you access to your home equity. Lower interest rates and shorter terms will save you money.
A shorter loan term loan can mean higher monthly payments than a longer term loan, but you won't have to pay as much interest in the long run, and rates on shorter term loans are typically lower. If you are in a position where you have a few hundred ‘extra’ dollars every month, you might want to consider switching to a 15yr fixed so you can own your house, free and clear, before you retire.
You may also drop mortgage insurance payments if you refinance at 80% or lower LTV.
It costs money to refinance. You may be charged for underwriting, a home appraisal, origination fees, and closing. These typically run around 1% of the loan balance but shop around, lenders are NOT created equally, and their rates/fees reflect this. In most cases you can finance in any of these related costs. Or ask your mortgage broker about no closing costs options.
Also have your mortgage broker show you how fast a refinance will pay for itself and start saving you money every month. If it will take three years, but you plan to move in two, it probably isn’t the best choice to refinance right now, unless you really need to. In contrast, if you will start seeing savings the first year, and plan to stay there for another 10 years, the savings can be huge.
Your original mortgage lender may have a prepayment penalty in place, meaning you'd have to pay extra for paying off the loan early so make sure to speak with your lender, or your next loan officer in depth about this. They will be able to quickly and easily see if your loan has a prepayment penalty.
Steps to Refinancing a House
Follow these 9 steps to successfully refinance your house.
1. Learn About Different Loan Types
Consider the three types of refinance loans. Decide which one best fits your needs and financial situation.
There are also different types of loan programs to choose from, including FHA, VA, USDA, and Conventional.
2. Decide What's Most Important To You
Is it cash out and preserving your equity? Is it lowering your overall monthly payments? Is it saving the most money over the life of your loan?
You won't know if refinancing is a good idea until you do some calculations. Contact a local mortgage broker or use a refinance loan calculator to compare the total cost of your current mortgage with other mortgages. You can find out how much money you'll save with different loans - if you can save.
Looking at a refinance loan may get you excited, but it doesn't mean switching loans is worthwhile. Figure out the break-even point.
Add up how much fees and closing costs are and divide this number by your estimated monthly savings. The final number is how long it will take to break even or earn back the amount you spent on fees and closing costs. After this point, you'll actually start saving money.
Typically, if it takes you more than three years to reach this point or you want to move out before you break even, refinancing isn't for you.
3. Know Your Financial Position
Know your credit score, and what you can verify in terms of income, employment and assets in the bank.
4. Know Your Home Equity
Find out how much balance you have left on your mortgage and get an estimate of your home's value. The difference between these numbers is your home equity.
Home equity that's less than 20% can mean higher fees and interest rates.
5. Choose Your Mortgage Broker
You aren't stuck with your original lender. Even if you do love them a mortgage broker can often get you a better deal with wholesale rates than going directly to a branch of your existing bank.
Many borrowers also become unhappy with their lenders and the way they are treated by them. A great mortgage broker can help you find one who will serve you well.
6. Make Your Refinance Loan Application
Make your official mortgage application. You can start the process online with easy to fill out forms, by calling your loan officer, or over Zoom, Skype or Facetime.
Tell the lender about your credit history, assets, liabilities, and other important financial information. They'll check your finances and credit anyway, so it's better to be upfront.
You may have to get a home appraisal as part of the approval process.
Inform your lender of the repairs and improvements you've made to the house since buying it. This can justify a higher value.
8. Gather Underwriting Conditions
Your lender may ask to see tax returns, pay stubs, and other things that give insight to your financial situation.
9. Close Your Loan
Finishing signing the final loan documents online, by mail or at an in person closing at your Seattle mortgage broker’s office, a title company or attorney’s office, or by having a remote closer come to you when it is convenient. Note that if you are taking cash out there can be a 3 day waiting period before you actually see the funds in your account.
Get Help To Think Your Refinance Through
This can be a very beneficial time to refinance your Seattle home loan. It may be one of the best times to refinance in history.
However, there can be many loan features and options to think through. Get the help of a trusted mortgage broker to compare your options, and see which really checks the most boxes on your wants list, and saves you the most money.