Since the beginning of 2019, mortgage rates have dropped from 4.51% to 3.75%. This is an unexpected, but welcomed, low. America hasn't seen a mortgage rate this low since 2016.
Now is the time to consider refinancing your mortgage. If this is the right choice for you, your home loan will have a lower interest rate and you'll save money.
Continue reading to learn what mortgage refinancing is and the steps to refinancing a home loan.
Applying for a refinance loan isn't always the best decision. It has its advantages and risks. 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. 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.
Types of Refinance Loans
There are three types of refinance loans to choose from. You can apply for a cash-out, 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 $2,000 or more, cash in your pocket, after the new loan is written. This extra money can be used to consolidate debt payments. For example, rather than having to pay multiple places like a credit card company and student loan lender, someone can pay them off with the extra mortgage money. Then they only need to make one payment, to the mortgage lender, every month.
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.
People with no cash-out refinances don't take out more money than is required by the refinance. They can opt to add it to the loan balance or the money comes out of their own pockets and covers 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.
Rate-and-term refinances change the interest rate of the loan or the term. Some people can 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.
When to Refinance
Although you can apply for a refinance loan at any time, you can save money when home loan rates drop. The trick to maximizing the rate is to have your loan already in process with a lender, then locking the rate immediately when the rates fall. If you have an adjustable-rate mortgage (ARM), you may decide to switch to a fixed-rate loan when rates start increasing.
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 cash-out refinance allows you to take out a loan that matches the current value of your home. A higher home value means you can get a larger loan that covers the cost of your house and gives you the leftover amount.
A refinance loan can lower your monthly payments, let you pay off your house sooner, and give you access to your home equity. Lower interest rates will save you money.
A shorter loan term does the same, although it doesn't seem like it. Monthly payments are more, but you won't have to pay as much interest in the long run. 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.
It costs money to refinance. You'll be charged for underwriting, a home appraisal, origination fees, and title insurance. These typically run around 1% of the loan balance but shop around, lenders are NOT created equally, and their rates/fees reflect this.
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 pre-payment penalty.
Homeowners who apply for a loan with the same term often end up paying a high amount of interest. Paired with the fees of refinancing, this isn't worth it. A loan with a lower interest rate or shorter term, such as 15 years, will cost you less.
Steps to Refinancing a House
Refinancing can backfire if you're not careful. Follow these 9 steps to successfully refinance your house.
1. Choose the Loan Type
Consider the three types of refinance loans. Decide which one best fits your needs and financial situation.
Even though you may have home improvements you want to make, that doesn't mean you can afford to refinance your house.
2. Mortgage vs Refinanced Mortgage
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. Those who will benefit from refinancing should consider a shorter term.
3. Credit Score Check
The lower interest rates you're hoping for won't be available if you have bad credit. Make sure you check your credit score before refinancing. If it's not great, find a way to boost your score.
4. Home Equity
Find out how much you have left on your mortgage and get an estimate of your home's value. You can also have a real estate agent calculate the value.
Home equity that's less than 20% usually means higher fees and interest rates.
5. Research Lenders
You aren't stuck with your original lender. Do some research and look for a lender with good rates and fair fees. Fees may or may not be added into your loan.
There is no such thing as refinancing without closing costs. If a lender offers this, they'll either put the costs into the mortgage or have you pay more interest.
6. Collect Lender's Requests
Your lender may ask to see tax returns, pay stubs, and other things that give insight to your financial situation.
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. The market value can go up because of this.
8. Use Cash to Close
If you can, pay closing costs with cash right after closing. This will prevent you from having a higher loan amount or interest rate.
You can find the closing costs on the Loan Estimate (LE) and Closing Disclosure (CD). In the case that you can't pay upfront, calculate the costs in your loan or interest rate. From there you figure out your adjusted monthly payment.
Make sure you keep a copy of the closing paperwork.
9. Pay Attention to the Loan
Lenders can resell loans on the secondary market. Pay attention to any mail you get about your refinance loan. You'll be notified if it's under another company.
Think the Refinance Through
Don't immediately jump at an opportunity for lower interest rates or a shorter loan term. Refinancing a house doesn't always work out. You could end up paying more instead of saving money.
Make the proper calculations and estimates to determine if getting a new mortgage is wise. Use this guide to help you understand your loan options and how to refinance your home.