As a homeowner, you may have considered refinancing your mortgage. Before taking this step, it's important to know the pros and cons of refinancing.
What Does a Mortgage Refinance Entail?
Refinancing means that you're paying off your current mortgage and creating a new one. A mortgage refinance essentially replaces your first home loan while using the same assets as collateral.
In some ways, the refinancing process does not differ all that much from what you experienced while obtaining your original loan. You’ll also pay costs that are similar to the first loan.
Here's how the home mortgage refinancing process works:
- Evaluate whether a refinance home loan makes sense for your individual situation. There are three major reasons to refinance: to get a better interest rate or terms of payment; cash out of your home; or a combination of the two. Also, ask yourself how long you plan to live in your home. If you plan to move in less than a year, you will likely not recoup the closing costs associated with mortgage refinancing.
- Understand your financial situation and credit rating; those with a better financial history will get a better rate on their refinance loan.
- Calculate your monthly expenses after obtaining your mortgage refinance, as well as any closing costs involved.
- Research mortgage consultants and be sure to meet with your top choices before making your final decision. You should feel confident about the consultant of your choice; don’t hesitate to ask for professional references or do an online background check before entering into any agreement.
- Apply for your home refinance loan. Your mortgage consultant will be able to present a variety of options based on your personal financial situation, risk tolerance, credit rating, and how long you plan to remain in your home. Your mortgage consultant must also give you a good-faith estimate of all closing costs within three days of your refinance loan application. During this part of the refinance process, you’ll also need to gather documentation pertinent to your credit and financial histories. After this is all gathered and all forms completed, your mortgage consultant will submit your application for approval.
- After your refinance loan is approved, you'll probably need to submit additional documentation requested by the underwriter. This is your opportunity to review your loan approval to make sure you understand the loan program, amount to be financed, and approved interest rate. You’ll get a closing statement a week or so before closing; review this carefully to make sure you understand all terms and fees. Provided all requests from the lender have been met, you’ll be able to sign your loan documentation and receive your home refinance funds.
Video: How to refinance a mortgage
When Does Refinancing Make Sense?
There are a variety of reasons to refinance your home loan. If interest rates have fallen since you obtained your original loan, or if you expect them to rise in the future, you may want to refinance your mortgage in order to lock in favorable rates.
Perhaps your credit has improved since you were approved for your original loan, and you believe you now might be eligible for a home loan with lower rates or more favorable terms. Additionally, you might wish to switch to a different type of mortgage – for example, you might currently have an adjustable-rate mortgage, but wish to switch to a fixed home loan in order to lock in those lower rates.
Many people also choose to refinance to a lower rate in order to gain substantial savings on their mortgage payments, thereby freeing up extra money each month. Others may wish to take advantage of the Home Affordable Refinance Plan, a $75 billion federal program offering homeowners with mortgage loans owned or guaranteed by Fannie Mae or Freddie Mac the chance to refinance to more affordable payments.
However, there are circumstances under which refinancing does not make sense. If you plan to stay in your house for a shorter term, you will likely not recover the costs involved with a mortgage refinance. Additionally, if you’ve had your mortgage for a long time, refinancing late in the loan term resets the loan amortization process, meaning that most of your monthly payments will go toward interest rather than paying down the principal.
If your current mortgage carries a prepayment penalty, you may be charged for paying off your home mortgage loan early. This will increase the amount of time it takes for you to break even in terms of cost. You should also not refinance your mortgage if you’ve already stripped the equity from your home, since you’ll get the best rates if you borrow less than 80 percent of your home's value. Finally, if your credit is poor, it may pay to postpone refinancing until you can qualify for more favorable terms.
Homeowners often make the mistake of refinancing their mortgages to cover debts such as credit cards. This can turn short-term debt into longer-term debt, when the better option is to pay down the credit cards and wait until the debt is less of an issue before attempting to refinance. Additionally, it also means putting a major asset – one’s home – on the line for an unnecessary reason.
What is the Difference Between a Refinance and a Second Mortgage?
A mortgage refinance differs from a second mortgage in that refinancing can offer extra cash in addition to lower rates, while there is no extra cash involved with a second mortgage. Closing costs also differ – second mortgages have lower closing costs than refinance loans. However, those higher costs may be compensated with lower rates over time.
Second mortgages carry the advantage of allowing borrowers to quickly build equity in their home, as opposed to mortgage refinance loans which reset the amortization clock, resulting in more money going toward interest than principal in the beginning.
Video: How to get a second mortgage
What Are The Home Mortgage Refinance Costs?
Though a home mortgage refinance will hopefully save you money in the long run, keep in mind that you will incur costs by refinancing. Typical closing costs will run you between 2 and 3 percent of the total loan amount. They may include the following fees:
- Application fee: This ranges from $250-$500, with an average of $400.
- Title insurance: Though this differs by state, typical costs are $225-$400.
- Document preparation fees: These range from $200-$400.
- Lender closing fee: The nationwide average is between $725-$750.
- Settlement fees: Approximately $350.
- Title examination: This differs from state to state, ranging from $150-$450.
Remember, it pays to shop around to compare the most competitive closing costs on your home mortgage refinance. Don’t just go with the first offer you see – do your research before signing on the dotted line.
Mortgage Refinance Calculator