Buying a home is a major milestone, but itâ€™s not the end of the journey. You might decide to refinance your mortgage in a few years or even later, and youâ€™ll want to know what to expect.
Homeowners refinance their home loan for a variety of reasons. Once youâ€™ve set a clear goal, youâ€™re ready to shop lenders, compare refinance rates and get the ball rolling. Youâ€™ll also have plenty of paperwork to fill out and an appraisal to navigate.
Hereâ€™s a step-by-step guide to help you get started.
Use a mortgage refinance calculator to learn how a mortgage refinance can work for you.
A mortgage refinance is when you replace your current home loan with a new mortgage, usually to meet a specific financial goal. Refinances tend to close more quickly than new purchase loans, and youâ€™re not limited to working with the same lender again. Once your refinance closes, the old loan is repaid in full and youâ€™ll begin making payments on the new loan according to the terms youâ€™ve agreed to.
The most common reasons to refinance your mortgage are to lower your monthly payments by reducing your rate or term, particularly if you bought your home when rates were higher. Homeowners also refinance to pay off their homes faster, eliminate private mortgage insurance or to take out cash from their built-up equity.
A home refinance isnâ€™t exactly a cake walk. You have to get approved for a new loan, have your finances and credit vetted (again), get an appraisal and pay loan fees. Itâ€™s important to have a goal in mind when refinancing your mortgage. Letâ€™s look at each reason you might refinance your home loan in greater detail.
Many people refinance their mortgage to lower their monthly payments. A rate and term refinance helps you do this by replacing your mortgage with a new loan sporting a lower interest rate, and for roughly the same term, or repayment period.
Tacking on another 30 years with a new loan when you are already years into an existing mortgage means youâ€™ll pay more interest over time and itâ€™ll take you longer to own your home free and clear. Depending on how much interest youâ€™ve already paid, you may consider shortening the term or making extra mortgage payments to save on interest and repay the balance faster.
Shorter-term loans tend to have lower interest rates because the lender risks its capital for a shorter time period. And the savings in interest payments could be substantial when comparing a 15-year fixed mortgage and a 30-year fixed mortgage. But there are drawbacks to a 15-year mortgage. More of your cash will be tied up in paying down your mortgage. That means youâ€™ll have less money for expenses and to save for retirement, college or an emergency fund.
When you first got your mortgage, you made a down payment of less than 20 percent, and youâ€™ve been saddled with private mortgage insurance premiums, or PMI, as a result. But in the years since you got the mortgage, you paid down some of the loan balance and the value of your house rose. If the outstanding loan amount is less than 80 percent of the homeâ€™s appraised value, you might be able to refinance into a new loan and remove private mortgage insurance.
This could be a solid move if you have a loan insured by the Federal Housing Administration, or FHA. FHA loans have annual mortgage insurance premiums that cannot be canceled if you put down less than 10 percent â€” even when your loan-to-value ratio falls below 80 percent. The only ways to get rid of FHA mortgage insurance is to refinance the loan or sell the home.
Homeowners with sufficient equity in their homes sometimes turn to cash-out refinancing to meet a specific financial need. In a cash-out refi, you refinance your home loan into a new mortgage for a larger amount, and receive the difference in cash to use as you see fit.
There are responsible ways to use a cash-out refi. You can use the money to add value back into your home through a major remodeling project. You also can use it to pay off high-interest debt or for educational expenses. To do a cash-out refi, though, you typically need at least 20 percent equity in your home.
Shop around with multiple lenders to get the best deals on interest rates and terms. Additionally, lenders generally offer the best deals to borrowers who have higher credit scores, a positive credit history, and a lower debt-to-income ratio.
As you shop, ideally you want to get a lower rate than what you currently have, but pay attention to the annual percentage rate, or APR. The APR gives you an overall picture of your total borrowing costs, including the loanâ€™s interest rate, lender origination fees, points and other loan charges.
These details, along with your new monthly payments, will be spelled out in the loan estimate each lender gives you. This is a three-page document lenders must provide to you within three business days of receiving your refinance application. You can use the estimate and a refinance calculator to compare loan offers and identify the best deal.
Make sure to shop around for the best home refinance rates and terms. Refinancing makes sense if it puts your finances on a stronger footing, so weigh your decision carefully.
If you donâ€™t qualify for a refinance or owe more than your home is worth, a government-backed mortgage program could provide some relief. Your lender might agree to modify your loan or find other solutions to make your monthly payments easier to manage if you face a financial hardship.