The Ultimate Guide to Refinancing
- Understanding refinancing
- Knowing your goals
- How to prepare
- Examining your options
- Working with an expert
- Getting through closing
- Managing your mortgage
Things change, and your home financing is no different. Regardless of whether you took your current home loan out 20 years ago, 5 years ago, or even last year, odds are good your financial situation and the economic climate has changed.
That’s where refinancing comes in.
Given today’s low rate environment and the wide range of refinancing options available to borrowers, now is an excellent time to reevaluate your present mortgage. It’s entirely possible that you’ll find an opportunity to save money. To help make that determination, you’ll need to understand the steps of the refinance process and figure out if it’s the right move for you.
When you engage in a refinance, you are agreeing to replace your existing loan with a new one. This means new terms, rates, and payments. Typically those terms and rates should be favorable to you, saving you money and justifying the refinance process.
One of the first items you’ll want to review is the terms of your current mortgage. You should have an understanding of what you are paying each month, your current interest rate, how long you have had your current mortgage loan, how much you will pay over the life of the loan, and if any pre-payment penalties apply.
This information will help you make a fair comparison against new rate quotes and programs that are being offered today and will clearly show if it makes sound financial sense for you to consider refinancing.
For example, here’s a basic look at what the difference between paying a 6% interest rate and a 3% interest rate could mean to you on a 30-year loan of $300,000:
Savings Per Month
Of course, there are many other factors you’ll need to take into consideration. You’ll want to determine the amount of equity you have in your home, as that will help narrow down what type of refinance loan you may qualify for, and if you’ll need to pay mortgage insurance.
You may be required to get an appraisal, which is simply a professional estimate of your home’s current worth. Understanding your home’s value today is critical in helping to determine the best financing options available to you.
As with any mortgage loan, a refinance will also require completing paperwork, including a loan application that will help determine your eligibility. Depending on the type of product you choose, your loan approval will be based on a variety of personal financial factors.
The good news is that there are a variety of programs available to meet the needs of different types of borrowers and situations, including traditional refinances, (where credit scores, current debt, and loan amounts will weigh greatly on approvals), as well as government programs designed to help homeowners who may not have ideal credit. Under the Making Homes Affordable Act, there are even several programs that can assist those underwater on their mortgage.
Also, keep in mind that you will be required to pay closing costs on your new loan, which vary depending on your lender and location. You will need to have a good understanding of what these costs will be and factor them in when determining if a refinance is right for you. You should examine your break-even point as well, which will clearly show you the amount of time it will take you to recoup the closing costs that you will incur with a refinance. For a clearer picture of this, let’s look at an example:
You have decided to refinance and will be paying closing costs of $5,000. The new loan will save $200 a month. The breakdown below shows you that it would take just over two years, (25 months to be exact) to recoup your closing costs.
Total closing costs:
Amount saved per month:
Amount saved per year:
$200 x 12 months= $2,400 per year
Amount saved in two years:
$ 200 x 48 months= $4,800 in two years
Amount saved in 25 months to fully recover closing costs:
$5,000 in 25 months
Depending on the length of time you plan to stay in your home, this may or may not make sense.
One final consideration to evaluate is tax implications. You should examine the tax deduction you’ll receive with the new loan versus the old. Are the deductions larger or smaller and how significant are the differences? The ability to write off mortgage interest is a significant deduction for many households and you’ll want to ensure you are not losing money by refinancing your loan. It’s best to consult with your tax advisor to review this before making a move.
There are many reasons you may want to consider a refinance and you should be clear on your goals before you begin the process. Be sure to share what you’d like to achieve through refinancing with your mortgage professional so they can help guide you toward the best product to fit your current needs. Below are just some of the key reasons homeowners typically opt to refinance.
Take advantage of lower interest rates.
Long-term interest rates are close to record lows, and the reality is that we may never see them this low again. If you are able to refinance before rates begin to climb, you may not only lower your monthly payment, but you could see tremendous savings over the life of your loan.
Tap into the equity in your home to pull cash out.
If you have a good deal of equity in your home, there may be an opportunity for you to refinance and use some of that equity for other purposes. This may be a good option if you need to use the money to pay down high interest rate credit cards or personal loans.
You may even want to opt for a cash-out refinance to help pay for college tuition or even fund a new business. Tapping one’s home equity is not without risk, and you will definitely want to consult your mortgage professional before doing so.
Move out of an Adjustable Rate Mortgage.
Perhaps you are currently in an Adjustable Rate Mortgage (ARM) that is set to adjust very soon. Your rate may be set to adjust much higher than the rate you could lock in today.
Converting to another type of loan could help prevent you from seeing a large spike in your monthly payment. You may also simply choose to move to a more stable fixed-rate mortgage product.
Shorten or lengthen the period of your mortgage loan to better meet your financial situation.
If you are in a position to do so, you may want to shorten the length of your loan and move into a 15- or 20-year to help pay your mortgage off sooner and save money over the life of the loan.
On the flip side, if your income has recently decreased you may want to consider a longer term, which can help to keep payments lower and more manageable each month.
Move from two mortgage loans to one.
Perhaps you had a piggyback loan on your original mortgage and are currently paying two separate loans. If that’s the case and you have one or both loans with high interest rates, you may be able to refinance into one loan at a substantial savings.
Take advantage of HARP if you have a Fannie Mae or Freddie Mac owned loan.
This program allows you to take advantage of today’s market and reduce your monthly payments regardless of whether or not you are underwater on your mortgage. This program also has a much greater level of flexibility to qualify.
Move out of a loan that requires Private Mortgage Insurance (PMI).
If you purchased your home with a conventional home loan and put down less than 20% you were required to pay PMI which helps protect your lender against default on your loan.
One way to remove this insurance is by getting your house appraised to show that you have reached 20% equity in your home. Unfortunately, for some loan types, you may have to pay PMI for the length of the loan or for a set period of time.
Another way to remove the PMI payment is by refinancing. If the value of your home has increased and you have greater than 20% equity, or you switch loan types when you refinance, you won’t be required to pay PMI, which could mean even more savings.
Just as you did when you first applied for your mortgage, you’ll want to ensure that you are well prepared for what will be needed to complete your refinance. You’ll need to do some of your own research to determine if in fact a refinance is the right move for you and your current financial situation. There are several items you’ll want to make sure you have covered:
Check your current mortgage.
You should not pursue a refinance without a complete understanding of your current mortgage. You will need to determine if you would be saving enough money to warrant pursuing a refinance. For instance, if you plan to move in the next year or two, it probably would not make sense. Also, if you will face a pre-payment penalty on your current mortgage and are just a few years into the loan, you’ll want to understand that penalty and factor that into your decision to proceed.
Review your credit report.
You will absolutely need to ensure there are no errors or issues on your credit report. With lending requirements tighter than they were in the past, you won’t want to hold up your loan as you try and get something squared away that could have been resolved before submitting your application.
Visit www.annualcreditreport.com for a free copy of your credit report. If you do find any errors or issues, address them immediately and then move forward with your application. Although programs exist today for a variety of borrowers, the better your credit score the more options you’ll have available to you.
Take a look at your current outstanding debt.
Take a look at all of your outstanding debt. In many cases, lenders will review your debt-to-income ratio to determine if it’s too high. This may impact your ability to qualify for certain products and some of the best rates. Lenders will typically review both your front-end ratio, which is the difference between your income and the mortgage loan you are applying for, and the back-end ratio, which is the ratio between your monthly income and your debt—including your loan.
Typically, lenders like to see your front-end ratio under 30% and the back-end ratio, which is typically looked at more closely, lower than 40%. Keep in mind, though, that under the federal Home Affordable Refinancing Program some of these requirements have been eased.
Verify you have funds to cover closing costs.
Your closing costs will vary depending on the fees you are being charged by the bank, lender, or broker you work with. You should be aware of these costs up front.
Keep in mind, you’ll also want to review how long it will take you to recoup your closing costs through your monthly savings and factor that into your determination to refinance. After all, if it will take you a few years to recoup the closing costs you’ll need to pay and if you are considering a move in the next five years, it may not be the best decision to refinance at this time.
However, if you will recoup your closing costs in two years and you plan to stay in the home for at least a decade or longer, then the cost savings over that period of time will be significant and more than likely would be a good move.
Contact lenders and compare.
Just as you would for any large purchase, it’s always a good idea to shop around and compare. Even if you are working with someone you have worked with in the past, call some additional lenders and feel confident that you are getting the best rate, service, and product you possibly can.
Just be sure to watch out for and steer clear of anyone who mentions additional fees but does not clarify what they are for. Also, be aware of any hidden costs that may be rolled into your loan. Always be sure you completely understand the quotes you are getting. If you have questions, don’t be afraid to ask for clear explanations.
As you begin to explore your product options, think about what you are looking for in a loan.
Do you prefer the stability of a fixed-rate mortgage? Are you concerned about a low credit score and qualifying for a conventional loan? Do you plan to move in the next five to 10 years? Are you late on your payments or owing a great deal more than your home is actually worth?
Consider your specific financial situation and needs when evaluating the different types of available products. Here’s a closer look at some of the programs you’ll find when you look to refinance.
As the name implies, a fixed-rate mortgage product is one where the interest rate is stable throughout the life of the loan. These loans are among the most popular and are typically offered in 30-year, 20-year and 15-year options. Some fixed-rate programs also allow a cash-out option so you can pull equity out of your home. There are a number of benefits to each of these programs.
A 30-year fixed rate may be ideal if you plan to stay in your home for a long period of time, prefer the stability of a fixed rate and have a good credit score and enough equity in your home to avoid PMI. Your payments may be lower, as you are stretching out the costs over a long period of time. The downside of this is that you will end up paying more interest on the loan as it stretches out over 30-years.
A 20-year fixed rate offers similar benefits to a 30-year, but for a shorter period of time. Typically you’ll see a better interest rate on a 20-year as well, and will have the ability to pay off your loan sooner, cutting down on the amount of interest you’ll pay over the life of the loan. Of course, since you are paying this loan off in 20-years, you will see slightly higher monthly payments than you would with a 30-year option.
A 15-year fixed rate will allow you to pay off your loan in the shortest period of time, saving you a substantial amount on interest over the course of the loan. You may also be able to secure the best rate for a 15-year loan and you will build equity much more quickly, however, your payments will be much higher since you are opting to pay your loan off in a shorter period of time.
You may find some lenders also offer ten-year fixed options and variations of the above programs where you pay the interest upfront on your mortgage loan for a fixed period of time and then the principal over the remaining life of the loan.
These loans are known as interest-only options. While not for everyone, they may better meet your needs if you expect your income to increase, are looking for low monthly payments, and don’t plan to be in your home for a long period of time.
For example, a 30-year interest-only fixed-rate allows you to only pay interest upfront for the first 10 years. After that initial 10-year period is up, you will then need to pay down the principal in just 20 years. If you plan to move in less than 10 years, you’d never even start paying the principal. You should be clear that you understand the advantages and disadvantages of these types of loans, as they differ a great deal from a traditional fixed-rate loan.
Adjustable Rate Options
An adjustable rate mortgage, referred to as an ARM, offers a low starter rate for a fixed period of time. Once that period of time expires, the ARM will readjust to a fully indexed rate, which could be much higher than your starting rate. This could mean your payments would increase at that time. These refinance loans are typically offered in a 30-year terms and offer initial low, fixed starter rates for 5, 7 or 10 years.
There are clear advantages to an ARM for some types of borrowers. First, the introductory rates are typically lower than those for fixed-rate options, so your initial payments may be lower. This type of loan is also ideal for a borrower who may only plan to be in a home for a short time and plans to leave before the ARM adjusts to a higher rate.
ARMs are also a good option if you expect your income to rise over time and want lower payments to begin paying back your loan. Keep in mind, there are inherent risks with these types of loans.
Although you may plan to move before the ARM adjusts, your plans may change or you may not be able to sell your home in the timeframe you imagined. Interest rates may rise dramatically, impacting the rate your ARM adjusts to, and you could see a tremendous spike in your actual payment. You also may not see the increase in salary that you thought you might, which could make it more difficult to keep up with higher payments once your ARM adjusts.
There are quite a few government programs you may want to look into when refinancing. Some of these programs have less strict qualifications and are designed to help the borrowers successfully manage their mortgage.
There are numerous refinance programs available through the FHA (Federal Housing Administration) from fixed rates to streamlined programs designed specifically for those holding a current FHA loan. Even if you hold a conventional mortgage an FHA refinance may make sense, as they typically have less stringent qualifications.
Similar to conventional fixed-rate options, you can obtain an FHA fixed-rate loan in a 30-year or 15-year option. The same benefits would apply as a conventional fixed-rate—the stability of a consistent rate over the course of a loan.
Also, credit requirements may be less stringent if you are concerned about qualifying under conventional guidelines. The downside may be that FHA does require mortgage insurance if you do not have greater than 20% equity in your home, so you’ll need to factor that into your total monthly payments and you will need to go through the complete loan application process if you are moving from a conventional to an FHA.
The FHA Streamline Refinance may be an excellent option if you have a current FHA loan in good standing and are looking for a quick refinance program that can lower your interest rate and payment without the need for an appraisal.
This program typically has much less stringent guidelines as it’s only open to those who have already been approved and gone through the FHA qualification process when obtaining their original home loan. However, there is no cash–out option with the FHA streamline program.
If you currently hold a VA Loan or are eligible to move to one, there are also several available refinance options
Cash-out VA Refinance
This program is designed to help you tap into the equity in your home. Perhaps your property has increased in value since your purchase and you’d like to take some of the equity to help pay off other bills. This loan will allow you to access up to 90% of your home’s current value.
A rate-term refinance is for an eligible borrower who may be currently in a conventional or ARM loan, that wishes to move to a VA loan. This program offers the ability to finance up to 100% of the property’s value and never requires mortgage insurance. This is a fixed-rate loan and provides the same level of stability as other fixed-rate products.
Interest Rate Reduction Refinance Loan (IRRRL)
This is a streamlined program for those borrowers currently in a VA loan. It is designed to help lower interest rates and change the overall terms of the loan such as moving from an ARM to a fixed-rate. There are typically no out-of-pocket expenses and no appraisals are required. Another great benefit of this program is that documentation requirements are eased and processing is usually quick.
Home Affordable Refinance Program (HARP)
As part of the Making Homes Affordable Program, borrowers who hold a Fannie Mae or Freddie Mac home loan who are unable to refinance under conventional methods, or are underwater on their mortgage, can take advantage of the HARP program.
This program has a number of requirements, so you should be sure to check with your lender; however, overall it is designed to help borrowers refinance to obtain lower interest rates and reduce their payments. If you are unsure if your loan is currently held by Fannie Mae or Freddie Mac, you can check here.
These are just some of the many programs available to you. It’s best to contact a loan officer to review your personal situation and explore the best product to meet your particular needs.
As you begin to determine that a refinance makes sense and you start to narrow down the products that best fit your needs, you’ll want to begin working with a lender and, more specifically, with a loan officer whom you can trust. As a refinance loan is a significant financial decision, you should seek an experienced, licensed loan officer who can help you make the best decision for your individual needs. You should have a level of comfort with both your loan officer and the lending institution they represent. Your loan officer must have the ability to provide sound advice and successfully guide you down the refinancing path.
If you’ve worked with someone in the past, you may want to start there. If it’s been some time since you worked with a loan officer, ask around for referrals from friends and family. Still, don’t hesitate to contact several different loan officers and interview them for the job. This is one of the biggest financial decisions of a lifetime for most people, and you want the best. Don’t settle for someone you are not comfortable with. Here are some questions you may want to consider when speaking with a lending professional.
Are you licensed?
Mortgage loan officers in all states must be licensed. You may verify licensing at the consumer Nationwide Mortgage Licensing System (NMLS) site.
How long have you been in business?
Given the complexities of today’s home financing requirements and the myriad programs available, your best bet is to look for someone well versed in dealing with a variety of financial situations.
Do you have a former client I may contact?
Reach out to former clients the loan officer has worked with and ask them how they liked working with that particular individual. What were their strengths and weaknesses? No one is perfect, but you’ll want to start out on the right foot and know you are working with someone who comes highly recommended.
Do you have referral partners that may be able to help me with other aspects of my financing (real estate attorney, accountant, etc.)?
An experienced loan officer should have a number of local professional referral partners they work with and recommend. This will assist you in the process of refinancing your loan should you need a real estate attorney or accountant to ask questions or assist with the process.
Why should I choose to work with you?
Although this may seem general, it’s a great question to really understand why a particular individual wants your business. Are they just looking to close a quick refinance, collect their commission and move on, or are they more focused in on expanding their customer base, building a relationship and working with you for the long haul?
Do they talk about guiding you through your mortgage refinance now and also helping you in the future? Do you believe they want to earn your trust and business for a lifetime? That’s the kind of loan officer you’ll want to work with.
What is your availability like?
Make sure you clearly understand your loan officer’s availability from the get-go. If they work afternoons and evenings and your free time is only in the morning, it may not be the best fit. Understanding these hurdles early on will save you time and headaches later on in the process.
How would you describe your level of service?
Get an overall feel for how they view their own level of customer service. As they answer this question you should be able to tell just how important keeping their customers happy really is to them. Do you get the impression they’ll work above and beyond for you? You should.
How frequently will you update me throughout the refinance process?
Gain an understanding on how frequently the loan officer plans to update you on your refinance. You’ll want to make sure their responses are clearly aligned with your desire for updates. You’ll also want to cover your preferred method of contact and ensure your loan officer can relay messages to you in the manner you’d like. It’s not uncommon these days to find customers preferring texts or emails over phone calls.
You may recall what closing day was like with your original home loan and with a refinance it may not be very different. In some cases, you will meet at the closing agent's or attorney’s office; however, this may vary. In other cases your attorney will work with the closing agent to arrange signing of all documentation without a formal meeting. Regardless of the location of your closing, the process will remain the same.
You will be required to:
- Carefully review and sign all loan documents.
- Provide a certified or cashier’s check to cover all closing costs.
- Set up an escrow account, as applicable, if you will be paying your homeowner’s insurance and taxes with your mortgage payment.
- Provide proof of homeowner’s insurance.
At the closing you will also receive copies of and will need to sign the following:
Closing Disclosure. This is a line-by-line itemization of your total closing costs.
Deed of Trust or Mortgage. This documentation details the lien on your property as security if you should default on the loan.
The Promissory Note. This is a document declaring your agreement to all of the terms of the loan, including your promise to pay your mortgage payments on time, in full and to the proper party throughout the life of the loan.
Your attorney should guide you through this process on closing day and explain each and every document you are signing. Be sure to address any questions or anything you don’t understand immediately.
Once your refinance has been completed and you have closed the loan, periodically check in with your loan officer. It’s usually best to plan a yearly mortgage review. This is a good opportunity to verify that the mortgage you are currently in remains the right fit for your particular financial needs.
Just as a refinance may have been right for you now, in the future your needs may change and you may find your goals have changed as well. Perhaps you’ll need to tap into some equity in your home and refinance again or you’ll decide to move and will need to shop for a new mortgage.
Regardless of the situation, reviewing your mortgage and how it fits your current financial situation makes smart financial sense and should be a commitment you make sure to keep each year.