Even though the home buying process means committing to a mortgage, it doesn’t mean that the same loan has to be permanent. Refinancing is an option for homeowners. There are a few different potential benefits, including a lower monthly payment, a shorter loan term, or an opportunity to get cash from your home.
Here’s some essential information about refinancing your mortgage.
What is mortgage refinancing?
Refinancing your mortgage is the process of getting a new loan for your home. This new mortgage loan replaces the old one.
Homeowners go through this process to get a better interest term and rate through a process that pays off the original loan. Typically, if borrowers have owned their house for at least six months, they are eligible to refinance. (Check out the specifics here.)
Why would you want to refinance?
There are a few different reasons to refinance your mortgage and when it’s a great choice.
- To lower your monthly payment. If interest rates are lower now than they were when you originally bought your house, a refinance at the current rate can lead to lower monthly mortgage payments. A cheaper amount holds massive appeal and can be worth it. Some borrowers also choose to extend their loan term, such as from 15 to 30 years, which lowers the monthly payment though also pays more interest over time.
- To tap into equity. Also known as a cash-out refinance, the borrower can refinance to borrow more than they owe on their current loan. The lender will send a check for the difference. So here, you can walk away with some cash as well as a lower monthly payment.
- To shorten the timeline. When refinancing from a 30-year to a 15-year, the borrower pays off the loan in half the time. There might be a higher monthly payment but less interest paid over time.
- To remove FHA mortgage insurance. While private mortgage insurance (PMI) on conventional loans can eventually be canceled, the FHA mortgage insurance is usually more permanent—it goes away when you sell the house or refinance the loan when enough equity has been built.
- To switch from an adjustable-rate loan to a fixed-rate loan. Fixed-rate lock their interest rates in for the entire life of the loan while ARM can increase over time. The change to a stable payment is an appealing reason to refinance.
The refinancing process
Because refinancing is getting a new home loan, it looks similar to the homebuying process, though it’s often less complicated. Many of the steps remain the same.
When applying, the borrower will supply their lender with the same information as last time: pay stubs, W2s, bank payments. They’ll be assessing credit scores, income, debt, and assets. The same rule applies: don’t be afraid to shop around for lenders with the best rates. Even if you had a great lender for your original loan, it’s still wise to look around to compare all your options.
After applying, the underwriting process begins. Behind the scenes, the lender will verify all of the supplied financial information and will look into the property. The borrower will need to pay for an appraisal to determine the property’s value, ordered by the lender.
Like last time, the appraisal is a critical step that will determine what refinancing options are available. For example, suppose a borrower is looking for a lower monthly payment. In that case, the value of their home will decide there’s enough home equity to be eligible for loan options or to eliminate PMI. For the appraisal, the house should be in its best shape—and it helps to have a list of upgrades made by the borrower to share with the appraiser.
If the home value comes back lower, the borrower can either cancel the refinance application or decrease the amount of money to borrow for the loan. If the home’s value is equal to or higher than the refinance loan amount, it means that the underwriting is complete.
Closing comes next, which will start with the review of closing disclosures—all the final numbers for the loan. The closing period is significantly shorter for a refinance than a home purchase. At closing, the borrowers and a representative from the lender or title company will go over the details of the refinance loan together. The borrower will pay any closing costs that aren’t covered by the loan, and the borrowers will sign many pages of paperwork.