Mortgage Refinance Guide (When & How to Refinance)

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For many, buying a home is one of the most expensive purchases made in one’s lifetime. After all, what else costs hundreds of thousands of dollars and takes years to repay? In order to afford a home, many homeowners take out a mortgage, which is a loan issued by banks or other financial institutions that allows customers to borrow money to purchase a home in exchange for monthly payments. Banks and financial institutions tack on an interest rate on top of the monthly payments, which is where they make their money.

The interest rate attached to your mortgage can add thousands of dollars to your home’s overall cost, which is why searching for a mortgage with a low interest rate can help save you money down the line. If you’re paying more than you’d like in interest every month, one way to get a lower interest rate is with a mortgage refinance.

Refinancing can be a great way to reduce the amount of money you pay month-to-month for your home. Below, we’ll cover different mortgage refinance options, when to refinance a mortgage, and how to refinance a mortgage. Read end-to-end for a full understanding of a mortgage refinance or jump to a specific section using the links below.

What Is a Mortgage Refinance?

A mortgage refinance, according to USA.gov, allows homeowners to pay off their existing mortgage and apply for a new mortgage with updated terms. When you refinance, the new mortgage pays off the balance of the old mortgage, and the money goes to the new mortgage lender. There are a variety of reasons why a homeowner may choose to refinance their mortgage, such as getting a reduced interest rate or accessing the equity in their home. 

Due to the COVID-19 pandemic, the Federal Reserve  set the federal funds rate to 0-0.25 percent to protect the economy and keep money flowing. While the Federal Reserve doesn’t control mortgage rates, the rates set by the Federal Reserve can have an impact on mortgage rates as the government creates or adapts monetary policy. The Fed also announced they will be buying mortgage-back securities (MBS) to ensure mortgage lenders have funds available for homebuyers and those looking to refinance.

What does this mean if you’re planning to refinance your mortgage? It means you might be able to find a mortgage with a better interest rate. However, it’s important to remember the Federal Reserve sets short-term interest rates, not mortgage, which means not every lender will follow the lead of the Federal Reserve and lower their own rates. Make sure to do your research and shop around to determine whether a mortgage refinance is right for you.

Mortgage Refinance Options

There are various mortgage refinance options for homeowners to choose from depending on their financial situation. Take a look at some of the most common mortgage refinance options below:

Rate & Term Refinance

A rate and term refinance is when a new mortgage replaces an existing mortgage with a change in the interest rate, term conditions, or both. This mortgage refinancing option is popular for homeowners who bought a house when interest rates were high compared to the current interest rates. Rate and term refinances may also help homeowners get approved for a new mortgage that can reduce their monthly bill because they can allow homeowners to get a new home loan with altered repayment terms, such as switching from a 30-year mortgage to a 15-year mortgage or vice-versa. 

However, when you apply for a mortgage refinance, your term starts right back at the beginning. So, if you paid off 10 years of your 30-year mortgage and are looking for a rate and term refinance with a new 30-year term, you will have to pay another 30 years for the new mortgage, bringing you to 40 total years.

A rate and term refinance may be a smart financial move, despite adding more years of debt repayment. This is because the new interest rate can be much lower than your original mortgage’s interest rate, ultimately saving you money. A new 30-year term can also make your monthly payments smaller because they’re spread across more years. 

You can also switch to a new 15-year rate and term refinance. While your monthly payments have the potential of being twice as much as a 30-year mortgage term because they’re condensed into 15 years, an advantage is that you will have fewer years of payment. For example, if you paid off 10 years of your current mortgage and are applying for a 15-year rate and term refinance, you will have five less years of payment than sticking with your existing 30-year mortgage. 

Cash-Out Refinance

A cash-out refinance is the opposite of a rate and term refinance, in that homeowners convert their home equity, or the market value of their home minus what they owe, into cash with a new mortgage. Compared to rate and term refinances, cash-out refinances typically come with a higher interest rate because lenders fear you may walk away from the loan. However, having a high credit score can help you get a new mortgage with more favorable terms.

When you apply for a cash-out refinance, the new loan will be for a larger amount than the outstanding balance of your current mortgage. The new mortgage will then pay off the remaining balance and give you the difference between the two, which will be paid in cash upon closing. Typically, most lenders will require you to have at least 20 percent equity in your home to be eligible for a cash-out refinance.

For example, let’s say you took out a $300,000 mortgage to buy a home, and after a certain amount of years, you still owe $150,000. This means, assuming the property value remains the same as when you first bought your home, you’ve built up $150,000 in home equity. 

Now, let’s say you want to convert $75,000 of your home equity into cash for large expenses, such as paying off debt or for a home improvement project. You can take out a new mortgage for $225,000 with a cash-out refinance. The new mortgage will pay off the $150,000 of your old mortgage and give you the remaining $75,000 in cash.

Streamline Refinance

A streamline refinance is when you refinance an existing FHA-insured mortgage. FHA loans, insured by the Federal Housing Administration and issued by FHA-approved lenders, are meant for low-to-moderate-income borrowers and take lower credit scores and down payments. With a streamline refinance, you can refinance your current FHA-insured mortgage for a lower rate or a different type of mortgage, such as a fixed-rate mortgage or adjustable-rate mortgage.

Qualifying for an FHA streamline refinance can be challenging. In order to qualify, you must meet these requirements:

  • The mortgage must already be FHA-insured.
  • The mortgage being refinanced must be current (not delinquent).
  • The refinance must result in a net tangible benefit to the borrower—for example, the refinance must show that refinancing with a reduced mortgage term, interest rate, or both, will benefit the borrower financially.
  • The borrower cannot take out more than $500 from the mortgage refinance.

There are two types of streamline refinances:

  • Credit qualifying, where the borrower provides income information and credit documentation, and the lender conducts a credit check
  • Non-credit qualifying, where no credit check is conducted by the lender

If you have an FHA-insured mortgage, a streamline refinance can be a good option if you’re looking for a lower interest rate, better terms, or both.

When Should You Refinance Your Mortgage?

Refinancing isn’t for everyone. Depending on your current financial situation, refinancing your mortgage can actually do more harm than good.

Here are some scenarios where a homeowner may want to consider refinancing:

  • Switch from an adjustable-rate mortgage to a fixed-rate mortgage: An adjustable-rate mortgage’s (ARM) interest rate changes over time depending on current interest rates. If you’re looking for more stability, a fixed-rate mortgage will have the same interest rate for the entirety of the loan.
  • Remove FHA mortgage insurance: If you have an FHA-insured mortgage, you’re required to pay for the FHA mortgage insurance premium. The only way to get rid of this expense is by either selling your home or refinancing when you’ve accumulated enough home equity.
  • Pay off your mortgage faster: Refinancing can allow you to go from a 30-year mortgage to a 15-year mortgage, which can allow you to pay off your home loan faster. This means you’ll pay less in interest over the course of the mortgage, but might have higher monthly payments.
  • Lower your monthly payments: If you want to pay less money every month, you can refinance to get a loan with a lower interest rate. Or, if you have a current 15-year mortgage, you can switch to a 30-year mortgage. However, doing so can accrue more interest over the course of the loan.
  • Get cash: If you need cash for any particular reason, such as paying for your child’s tuition, building an emergency fund, or making home improvements, a cash-out refinance can put money in your pocket and even lower your interest rate in some cases.

How to Refinance Your Mortgage

The steps you take to refinance your mortgage are similar to those when you apply for the initial mortgage to buy your home. 

Here’s how to refinance your mortgage:

  • Step 1: Determine why you want to refinance your mortgage. Is it to get a lower monthly payment? Take out equity from your home for large purchases? Shorten the length of your loan? These are just some of the questions to ask yourself.
  • Step 2: Review your credit score—as with most mortgages, the higher the credit score, the lower the interest rate. With a high credit score, lenders might be more willing to approve your loan.
  • Step 3: Shop around for different mortgage lenders to see which ones offer the lowest rates and best terms. 
  • Step 4: Once you’ve found a few mortgage lenders, fill out their refinancing application and provide any useful financial documents, such as pay stubs, bank statements, and your tax returns.
  • Step 5: Choose your lender and prepare for closing. Once you lock in your interest rate, you’ll have a brand-new mortgage.

Risks and Costs of Refinancing Your Mortgage

A home loan refinance can be a great way to lock in a lower interest rate and get better terms. However, refinancing doesn’t make sense for every situation, especially for those who can’t get a lower interest rate or have to pay hefty fees. Take a look at some risks and costs of refinancing your mortgage:

Risks of Refinancing Your Mortgage

Most decisions in life come with some risks, including refinancing your mortgage. Before you sign on the dotted line and apply for that new mortgage, consider these risks:

  • Penalties: Mortgage lenders are allowed to impose penalties if you pay your mortgage off before the term ends, which can sometimes be thousands of dollars.
  • Fees: During closing, there are a variety of fees you may be responsible for paying, such as attorney fees, inspection fees, appraisal fees, and title insurance.
  • Length: Refinancing your mortgage to a new mortgage with a longer term means it can take longer to pay off.
  • Commitment: If you plan on moving in the near future, refinancing your mortgage might not be a good option, as savings most likely won’t outweigh closing costs.

Understanding what’s at stake can help you decide whether a mortgage refinance is right for you.

Costs of Refinancing Your Mortgage

While mortgage refinances are aimed to save you money, they can come with some hefty costs. According to the Federal Reserve, here are some costs you can expect with a mortgage refinance:

  • Appraisal fee: $300 to $700
  • Inspection fee: $175 to $350
  • Attorney review/closing fee: $500 to $1,000
  • Homeowner’s insurance: $300 to $1,000
  • Title search and title insurance: $700 to $900
  • Survey fee: $150 to $400
  • Repayment penalty: one to six months’ interest payments

In total, refinancing your mortgage can cost three to six percent of your outstanding principal in fees. However, refinancing fees vary lender to lender, and not every lender will require all of the fees above. 

Wrapping Up: When and How to Refinance

A mortgage refinance can be a great way to keep more money in your pocket every month. Whether you want a new mortgage with a lower interest rate or are looking to tap into the equity of your home, mortgage refinances may help you meet your financial goals. After you’ve decided it’s time to refinance, shop around for lenders with the best rates and terms, and you’ll be on your way to getting a new mortgage that works for you.

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