Refinancing: The Ultimate Guide To Refinance Loans
It can seem like the hoops you need to jump through to buy a home are endless. But once you’re approved for a mortgage and have closed on your house, you’re done dealing with home loans forever right? Not quite. It’s possible down the line that refinancing your mortgage could be beneficial to your situation. So what is refinancing? In its simplest terms, refinancing means you’re taking your existing mortgage and replacing it or paying it off with a new mortgage. Why in the world would anyone want to do that? For many people, it comes down to keeping more money in their wallets over the term of their new loan.
Everybody likes to save money, so you might be asking yourself if refinancing is the right move for you. This guide is here to help! It breaks down the mysteries and misconceptions associated with refinancing and answers common questions about the topic.
What is refinancing?
The term refinancing is one steeped in mystery for many people. In the case of mortgages, refinancing simply means to finance your home again, typically with a new loan at a lower rate of interest. When you refinance your mortgage, your bank or lender pays off your old mortgage with the new one.
Your mortgage payment
To better understand refinancing and why it could save you money, let’s break down the costs associated with your mortgage payment.
Principal: First up, there’s the principal, which is the amount of money you borrowed to buy your home. The balance of your principal reflects how much of the loan you have left to pay off.
Interest: Interest is the money you pay to use the money you’re borrowing. You receive an interest rate when you’re approved for a mortgage. The interest rate can factor in big when it comes to refinancing.
Property taxes: Property taxes are paid to a government agency—in most cases, your local city government—and typically fund services such as fire and police protection, utility infrastructure construction and repair, and other types of improvements.
Homeowners insurance: Also known as hazard insurance, this type of insurance covers damage and losses to your house and assets.
Mortgage insurance: Last but not least is mortgage insurance, also known as private mortgage insurance or PMI. This type of insurance protects your lender in the event you are unable to pay back your mortgage. It usually is included in situations where buyers don’t make a down payment of 20% of the house’s price.
Each of these elements has a role to play in refinancing but some have bigger impacts than others.
Types of refinancing
Just as with mortgages, there are different types of refinancing you can pursue. Which loan works best for you will depend on your current mortgage and situation.
Rate-and-term refinancing: This is the most common type of refinancing. Rate-and-term refinancing occurs when the original loan is paid and replaced with a new loan agreement that requires lower interest payments.
Streamline refinancing: If you have a government-backed housing loan, such as one through the Federal Housing Administration (FHA), Veterans Affairs (VA), or the U.S. Department of Agriculture (USDA), it’s possible you could qualify for a streamlined refinancing. This type of refinancing requires a smaller amount of paperwork than others, hence the name “streamline.” You might also see this type of refinancing referred to as an interest rate reduction refinance loan (IRRRL).
Cash-out refinancing: As the name implies, cash-out refinancing allows you to take money out of your home to use for expenses such as a renovation, paying off other debt, etc. How it works is by capitalizing on the value of your home or the equity you’ve put into your home. Equity refers to the portion of a home’s current value that you actually possess—essentially what you’ve paid into your home. Say you buy a $200,000 home with a down payment of $40,000 and a mortgage to cover the rest. At that moment in time, the amount of equity in your home is $40,000. Your equity grows as you pay down your mortgage and your home gains value.
Cash-out refinancing allows you to withdraw money from your home’s increased value or equity in exchange for a higher loan amount. So if you took out a $200,000 mortgage to purchase your home and now have $60,000 in equity, you can refinance to a mortgage of $260,000 if you want to spend your full equity. In this case, you get access to $60,000 and retain ownership of your home. Or if your home has increased in value by $30,000 since you purchased it, you can refinance to a loan of $230,000 and withdraw the difference between the purchased value and current value—in this case, $30,000.
Cash-in refinancing: As you can probably guess, a cash-in refinance is the opposite of a cash-out. A cash-in refinance allows you to pay down some portion of the loan for a lower loan-to-value (LTV) ratio or smaller loan payments. The LTV ratio is a value that reflects your lending risk and is examined by lenders before you’re approved for a mortgage. By lowering your LTV, it’s possible that you could qualify for a lower mortgage interest rate and save money in the long run.
Consolidation refinancing: As the name suggests, consolidation refinancing seeks to combine multiple loans into one with a better interest rate. In this scenario, you would apply for a new loan at a lower rate and then pay off your existing debt with the new loan. That means you’ll have one principal with substantially lower interest rate payments.
When meeting with a mortgage professional to discuss these refinancing options, make sure they’re talking to you about your goals and long-term plans. Based on that information, they should be showing you a few refinance products—not just one.
The refinancing process
With the types of refinancing you can pursue in mind, let’s get into how the process works.
The refinancing process is very similar to getting a mortgage when you purchase your home. You need to get pre-approved or have a mortgage professional review your mortgage information and your credit. This is where a mortgage adviser should give you a few options—and don’t be afraid to get a second opinion.
If the numbers make sense, and you want to go through with the refinance, that’s when you need to make an official mortgage application. This is where you will sign the loan paperwork and order an appraisal just like when you found your house and you applied for a mortgage.
After you’ve applied for your loan, your loan officer will send your application and your personal information to an underwriter. This person examines all of that information and if everything is satisfactory, they’ll issue a loan approval. The loan approval includes any new conditions on the loan, such as a lower interest rate. Once your team and the lending team agree on the conditions, then it’s on to closing. A closing disclosure is issued, and a closing date is scheduled.
Unlike closing on a house, you won’t be showing up at one meeting to finalize paperwork and collecting your keys with a refinance. Instead, there will be a three-day rescission (holding) period that gives you time to contemplate your decision to refinance and back out if you think it’s no longer the best option for you. If it is the right choice for you, then go ahead and sign those closing papers.
Reasons to refinance
So why do people refinance? There are a few common reasons.
Lower interest rate: The first and most common reason for refinancing is to secure a lower interest rate on a mortgage. When you refinance to a lower interest rate, you’re saving on the difference between your original and new rate.
Shorter mortgage term: People also refinance as a means of decreasing the length of their mortgage term. For example, if you purchased a home with a 30-year mortgage at 5% interest, you could possibly refinance to a shorter-term of 20 years at a lower rate and still have the same payment you’re making on your mortgage now.
Cash infusion: Another reason people choose to refinance is to pull cash out of their homes. As covered in the cash-out refinancing section, you can use this money to pay for school tuition, pay off medical bills, pay for home renovations, or invest money into stocks or property.
Home renovation: Finally, many people choose to use refinancing as a means of completing home renovations. In some cases, homeowners might not have equity to pull cash from, so there are options for you to refinance and roll your renovation costs and mortgage into one new loan.
Should I refinance? When is the best time to do so?
The answer to this question will depend on your personal situation. It’s best to take this question to a mortgage professional who can evaluate your current situation and determine if refinancing is the best course of action to take. Like home buying, refinancing is a complicated and sometimes convoluted process, so be sure to find a professional who is happy to take you through scenarios and explain everything to you—they should be playing the role of teacher, not a salesperson.
In general, refinancing comes down to if you can save money and if it makes sense with your overall life plan. For instance, if you plan on selling your home in the next two or three years, you might be better off not doing a refinance. But, if your plan is to put down roots and stay in your home for a long period of time, it’s possible that you could save money on your mortgage by refinancing.
Interest rates tend to drive refinancing trends, but there is no magic crystal ball that will tell you if rates are going to go higher or lower. In the end, the best advice is to work with a mortgage professional whose experience and recommendations you trust. You can save a lot more money by having a seasoned mortgage adviser in your corner who can give you all your options and look at the big picture to see if refinancing will save you money.
Building on that point, don’t ever feel like you’re bugging a mortgage professional with questions. Refinancing is a scary process that you may only go through once or twice in your life, but these professionals handle them every day and can provide valuable guidance and insight.
It’s worth noting that refinancing also depends on your equity and your credit score. If your score is lower than when you purchased your home, you may not get approval from your lender.
Does it matter what type of loan I have to refinance?
Depending on what kind of loan you have, refinancing may prove beneficial down the line. For example, loans guaranteed by the FHA come with conditions that make them ideal for refinancing. FHA loans have mortgage insurance costs that will remain for the lifetime of the loan unless certain conditions are met.
Traditional home loans often require buyers to acquire mortgage insurance if they cannot meet the minimum down payment—typically 20% of the home price. Once the buyers have made mortgage payments that total 20% of the home costs, the mortgage insurance will typically be removed, thus lowering the overall monthly payment.
It is possible to refinance your FHA loan into another type of FHA loan or even into a conventional one at the same or higher interest rate and, in doing so, drop the mortgage insurance and save money in the long run. If you refinance your FHA loan into another type of FHA loan, you are eligible for a refund of your mortgage insurance costs. That said, it’s better to refinance sooner rather than later after you’ve purchased your home because the FHA reduces a borrower’s eligible refund amount by two percentage points for each month after the initial closing date.
One notable thing about the past few years is that homes are gaining value more quickly than normal. So if you purchased a house last year, you’ve already gained quite a bit of equity in your home. If you were looking to mortgage refinance, an appraisal would show a higher value than what you paid for your home. That means you could potentially see your mortgage insurance costs drop off more quickly than normal. So even if your loan interest rate stays the same, you could still save $100 to $300 a month by refinancing, depending on how big your loan is.
Should I wait for interest rates to drop before I pursue refinancing?
Not necessarily. Some experts may say that your interest rate should drop by at least 1% to make refinancing worth it. Sometimes the type of loan you have and the type of loan you refinance it into can be what saves you money, not just a lower interest rate.
For example, let’s say you have an FHA loan with a 3.8% interest rate. You decide to refinance and convert that FHA loan into a conventional loan with the same interest rate. You see that your monthly housing payment will drop by $100. That’s because FHA loans require borrowers to have mortgage insurance for the life of the loan. When you switch to a conventional loan and the amount of equity you have in your home is equal to or exceeds that 20% down payment, you get to drop the cost of mortgage insurance. Over the lifetime of the loan, that extra $100 a month can add up fast.
Now, what if you can refinance your loan but to a slightly lower interest rate. Is it worth it? Possibly. In another example, you have a conventional mortgage with a 3.5% interest rate. In this refinancing scenario, you get a new rate between 2.6 and 2.75%. It’s not a full percentage point drop, but on a mortgage of $300,000, you’d save about $150 a month. That’s about $1,800 per year, which is a good chunk of change for many households.
In either case, waiting on a full percentage point drop meant you would have missed out on savings, so it’s best to have a mortgage professional take a look at your situation and figure out the most favorable course.
Do I have to pay closing costs when I refinance?
The short answer is yes, you will need to pay closing costs as part of your refinance. Typically, your closing costs are going to be somewhere in the range of 2 to 4%. And that value is based on your loan amount, but also your credit score, the lender that you’re going with, and the type of loan that you’re refinancing into.
There are two common misconceptions about closing costs when it comes to refinancing. The first is the existence of closing costs. You’ve probably seen ads offering refinancing with no closing costs.
There is no such thing.
You are paying somewhere. There are always costs associated with refinancing. If there are not any closing costs rolled into your loan that increases the principal, then the interest rate has likely been increased to cover some of those costs. Just like there is no such thing as a free lunch, there is no such thing as free closing costs.
Another thing people often misunderstand is when you refinance that you also need to set up a new escrow account. An escrow account is a separate account managed by a lender to collect advance insurance payments and tax payments from a homeowner. Setting up a new account is not a closing cost. Closing costs refer to the appraisal fee, your underwriting fee, and title company fees.
When you refinance, you have to set up a new account. You’ll need to place money in the account as part of the setup, but you’ll get it back after closing. So some people choose to bring this money to closing knowing they’re getting it back while others choose to roll it in and use the money later on something else.
If I want to refinance my home, do I need to get it appraised again?
It depends. You may or may not need an appraisal depending on your loan type, credit score, and other factors. Typically, you will need to get an appraisal when you refinance. Keep in mind the appraisal protects the bank by confirming that it’s not lending you more money than your property is worth.
There are appraisal waivers you can get for refinancing. As the name suggests, an appraisal waiver simply means that your lender doesn’t require an appraisal in order to move forward with your loan. However, this only works for borrowers with a conventional loan. You can’t get an appraisal waiver for a VA loan, an FHA loan, or a USDA loan. You can ask your lender if your refinancing qualifies for a waiver. These waivers were uncommon but more have been issued in the wake of the COVID-19 pandemic as appraisers struggled to evaluate homes while adhering to health and safety guidelines.
If you don’t qualify for a waiver, then you’ll need to get another appraisal done on your home as part of the refinancing process—even if you purchased or refinanced in the last 12 months.
What will refinance cost me out of pocket?
A majority of refinancing doesn’t involve out-of-pocket costs. Depending on your type of loan or refinancing, you may be able to roll the closing costs and other charges into your new loan. This results in higher payments but won’t hit your checkbook with a big charge.
If you’d rather pay the closing costs upfront, then you’re on the hook for the appraisal fee, your underwriting fee, and title company fees. In total, your closing costs will average between 2% and 5% of the loan amount.
How long does the refinancing process take from start to finish?
Without the phase of house hunting, it’s easy to assume that refinancing is a much faster process than getting a mortgage. But just like any other loan, the national average for closing a refinancing loan is about 50 days. Keep in mind that’s average, so your refinancing might go quicker at 30 days or even longer at 60 days.
In the end, how long refinancing takes depends on your house, the type of refinancing that you’re going with, and if is an appraisal is taking place. If you’re on a time restraint, ask your loan officer what is the most realistic timeframe, and what can you do to help speed it up.
Can or should I refinance a home more than once?
There are no regulations that limit how often you can refinance your home, but lenders typically set their own limits. The first thing you need to think about when you ask this question is how long you plan to stay in your current home. If you’re living in what you believe will be your forever home, it can make sense in certain scenarios to refinance (sometimes multiple times) and save money on loan interest.
Conversely, if you plan to move in a few years, refinancing might not save you money. There are costs associated with refinancing, and if you’re not recouping them before you move, you’re not really saving any money even if refinancing lowered your monthly mortgage payments.
In the end, much of this decision will come down to your long-term goals for your life in general and for your finances. A mortgage professional can help you determine if refinancing will help you meet those goals.