Your home probably came with a 30-year fixed-rate loan when you bought it. Even though that might have felt like a lifelong decision, homeowners often have the option to refinance their mortgages.
A mortgage refinance basically means you switch from the terms of your old mortgage to those of the new one. If interest rates drop, for example, you can refinance so that your mortgage reflects the lower rate. Or, perhaps you could refinance to a 15-year term instead of a 30-year one.
However, before refinancing, use Due’s refinance calculator to determine if refinancing makes sense for you.
Mortgage Refinance Calculator
When it comes to refinancing a mortgage, it’s all about the numbers. By lowering their interest rates, lowering their monthly payments, reducing their loan term, or avoiding mortgage insurance premiums, borrowers can save money. Check the numbers to determine if refinancing will save you money before shopping around for lenders. You can find out how much you stand to save (or lose) by using the Due Mortgage Refinance Calculator.
What is Mortgage Refinancing?
The concept of refinancing your mortgage is basically to exchange your current mortgage for a new one with potentially a new balance. Banks or lenders refinance mortgages to pay off their old loans with new ones, which is why the term refinance is used. By refinancing, borrowers are able to lower their interest rates and shorten their payment terms. Another reason is so that they can cash out some of the equity they’ve built in their homes.
Generally, refinancing can be done in two ways: through a rate-and-term refinance or through a cash-out refinance.
Rate and Term Refinance
Refinancing your mortgage will typically result in a lower mortgage rate and a shorter term. As an example, you are converting a 30-year mortgage into a 15-year term.
A 15-year mortgage may be more affordable than your original 30-year mortgage, especially with the recent low-interest rates. Even though 15-year mortgage payments are usually higher than 30-year mortgage payments, you would be paying less interest on your new mortgage.
It’s important to find your break-even point before refinancing your existing mortgage rate. As the monthly mortgage payment becomes lower, the refinancing costs are essentially “recouped.”
Cash-Out Refinance
When you refinance your home for cash, you can borrow up to 80% of its current value. As a result, it is referred to as a cash-out refinance.
As an example, say your house is worth $100,000, but you owe $60,000 on the loan. A bank or lender can give you $20,000 in cash-out as a qualified borrower. In turn, your new mortgage is $80,000.
With a cash-out refinance, you may not always save money. Instead, you get a low-interest loan. A cash-out refinance might help you dig a new pool for your backyard or take that dream vacation you’ve always wanted.
It is important to be aware that taking a cash-out mortgage increases the value of your lien. The result could be higher payments and/or longer repayment terms. It is important to remember that this is not free money. You must pay the lender back.
When it comes to refinancing your mortgage, don’t take it lightly. Think about how much you can save by refinancing versus how much you will pay for the refinance. Educate yourself about the pros and cons of refinancing and other options available to you by consulting a financial planner.
How Does Refinancing Work?
As with your first mortgage loan, refinancing a mortgage involves similair steps. As a refresher, you will need to follow these steps.
Make an assessment of your financial situation.
Qualifications for refinancing a mortgage are the same as those for obtaining a new loan. Several factors will be considered by lenders, including:
- A review of your credit history and score
- Your existing loan payment history
- Employment history and income
- The home’s equity
- The current value of a home
- Owing other debts
In order to determine your eligibility, you should review where you stand in each of these areas. A new loan may be approved for better terms if you have a good credit history, a solid income, and a lot of equity in your home.
On the flip side, having bad credit or having a lot of overall debt can complicate your chances of getting approved for a more favorable mortgage.
Weigh all of your options.
Compare interest rates and other terms with multiple mortgage lenders during the preapproval process. As a result, you will be able to discover the best offer available to you.
Furthermore, you’ll want to compare refinancing offers with your current mortgage loan terms in addition to comparing refinancing offers. If you are considering refinancing, this can help you make an informed decision.
Crunch the numbers.
Identify the best offer and compare potential savings and costs once you have chosen it.
You would need to stay in your home for 50 months to make refinancing worthwhile if it costs $5,000 up-front and your new payment is $100 less than your previous payment. There may be no point in refinancing if you are not planning on staying in the home for a long time.
In addition, be aware of prepayment penalties, which can cause problems if you decide to pay off your existing mortgage or refinance.
Submit your application.
If and when you’re ready to apply, you’ll contact the lender directly. The information you provide will include your name, address, and mortgage loan information.
As part of the application, you’ll also need to provide documentation. Here are some things you might need:
- The most recent pay stubs
- W-2 forms
- Tax returns
- Bank statements
- Investment account statements
- Child support and alimony information — if applicable
- Copy of your government-issued photo identification
- Legal proof of residency in the U.S.
- Business income statements
- A letter explaining that you do not have to repay gifted money — if applicable
According to ICE Mortgage Technology, a company that works with lenders, this process can take 48 days on average. The closing process can, however, be sped up by some lenders.
Close your loan.
To make everything official, you’ll sign paperwork once the lender is ready to close the loan. As soon as your original loan is paid off, your new loan will be opened and your lender will open an account for it.
You’ll receive the cash as a check or wire transfer if you’re getting a cash-out refinance.
How Much Does it Cost to Refinance?
The average closing cost for a mortgage refinance is $5,000, according to Freddie Mac. However, closing costs vary depending on the loan amount and state of residence.
The closing disclosure for your refinance loan includes the following expenses:
- Appraisal fee. In order to estimate a property’s value, a professional appraiser examines it.
- Attorney fees. Documents and contracts are prepared by attorneys. However, not every state requires lawyers
- Escrow fee. Fees are paid to the real estate agency or an attorney responsible for closing the loan.
- Insurance fees. A current homeowners insurance policy is required.
- Points. A discount point is equivalent to 1% of the loan amount and may be purchased at closing to lower the interest rate on the loan. Each point costs 1% of the loan amount.
- Underwriting fee. An evaluation fee is charged to cover the costs associated with the loan application.
- Tax service fee. In order to ensure that the borrowers pay their property taxes, this fee is charged.
In a mortgage refinance, what is the break-even point?
If you’re going to refinance a mortgage, you need to figure out when your costs will break even. To figure out what the break-even point is, add up all your refinancing closing costs and figure out how long it will take you to make them up with your new mortgage payment.
As a general rule of thumb, you should refinance your home if you plan to stay there longer than break even. Otherwise, you could lose money.
Why is it important to stay in your home for a long time?
You should think about how long you’re planning on staying in your house before refinancing. Even if you get a lower interest rate, refinancing if you plan on moving in a few years may not make financial sense because you won’t have enough time to break even.
After refinancing, most experts recommend staying in your home for two to five years. But you should calculate your own break-even point.
When Should You Refinance Your Mortgage?
There are times when refinancing can be a good financial move, but it’s not always a good idea.
There are several reasons for refinancing a mortgage, including:
Low-interest rates.
When you lock in a lower interest rate, you can expect the following:
- Having a lower monthly payment
- Mortgage payments that are lower over the course of the loan
If you want to refinance at the lowest possible rates, you should have at least a 740 credit score.
Shorter loan term.
By spreading your loan balance over a shorter term, you will be able to:
- You will be able to pay off your mortgage more quickly
- Over the life of the loan, you’ll pay less interest
In general, 15-year loans have lower APRs than 30-year loans. Those with few long-term debts and who can afford the monthly mortgage payment should consider this option.
Cash is now at your fingertips.
In the case of a cash-out refinance:
- The majority of banks require you to keep at least 20% equity in your home in order to qualify for a mortgage
- A high credit score is required
A cash-out refinance also tends to have a higher interest rate. Therefore, most borrowers use this type of refinance to pay for home renovations or consolidate their debts.
Eliminate mortgage insurance payments.
Private mortgage insurance (PMI) should be automatically canceled on conventional loans once you reach 80% equity. FHA loans, however, require you to pay lifelong mortgage insurance premiums (MIP).
It can be beneficial to refinance a conventional loan if you have enough equity. An annual premium of 0.45% to 1.05% is charged by the FHA for mortgage insurance.
Make the switch from adjustable-rate mortgages to fixed-rate mortgages.
You will have the same interest rate and monthly mortgage payment for the life of your fixed-rate mortgage. Examples include until you sell, refinance, or finish paying. Most borrowers prefer fixed-rate mortgages because of their predictability – especially when interest rates are low and they plan to stay in their homes for years.
Removing a borrower from a mortgage.
If you divorce, you may want to refinance so that your former spouse does not appear on the loan anymore. Buying a home with a family member or friend might also apply in this case. Refinancing a loan into your name means you have to qualify for the new loan with just your income and credit score.
It is important to keep in mind that removing someone from a mortgage does not eliminate them from the real estate deeds. This may require you to file a legal document called a quitclaim deed. If you are unsure, check your state’s property laws for guidance.
When Should You Not Refinance Your Mortgage?
There are some situations where refinancing makes sense. Getting a refinance may not be the best choice, however, if the cost of the new loan exceeds how much you would save by refinancing, if your financial situation is uncertain, or if your credit score has fallen.
There are other reasons why refinancing might not be a good idea:
When you plan to move in the near future.
It might not be worth refinancing your loan if you’re planning to sell in a few years.
Divide the closing costs you’d save each month with the new payment by the amount you’d save with the new loan. That’s the break-even point for your new loan.
Again, a mortgage refinance typically costs around $5,000, according to Freddie Mac. Refinancing might not be worthwhile if you plan on staying in the home for less time than it would take to recover your closing costs.
Your credit score has dropped.
Lenders use your credit score when determining your creditworthiness for a refinance loan. With that in mind, a higher credit score increases your chances of receiving a low rate.
You might not qualify for a lower rate if your credit score is lower than when you bought your house. Prior to refinancing, you might want to work on improving your credit score.
How Do I Qualify for a Mortgage Refinance?
To qualify for a refinance, you must meet the requirements of your lender. Typically, the following standards must be met by your lender:
- Credit score. A credit score represents how well you manage credit and loans. If you want to know what credit score you need to qualify for each type of loan, you should ask your lender.
- Debt-to-income (DTI) ratio. An individual’s DTI is a measure of how much of her or his income goes to regular, recurring expenses. When your DTI is high, you’re less likely to have savings and more likely to miss payments on your mortgage. Depending on your loan type, your lender should be able to tell you how to calculate your DTI.
- Home equity. You have equity in your home if you have paid off a percentage of your loan principal. Before you can refinance your home, most lenders require that you have at least some equity. You can find out how much equity you have in your home and how much is needed to qualify for a refinance from your lender.
Again, lenders and loan types vary in their credit score requirements. High scores, however, always mean better rates. Credit scores can be gradually improved by checking for errors in your report and correcting them if needed.
Annualcreditreport.com offers three free copies of your credit report each year.
In the end, paying your bills on time and keeping tabs on your credit utilization rate are the best ways to improve your credit score. Keep in mind that improving your credit score can take a long time. As such, patience is key.
FAQs About Mortgage Refinancing
1. What is a mortgage refinance?
Refinancing your mortgage simply means replacing your current loan with a new one.
2. What types of loans are available?
Home loans come in a variety of types. The following are some of the most common types of mortgage loans:
- Conventional loan. These are the most common type of loans. They’re guaranteed by Fannie Mae and Freddie Mac.
- VA loan. Members of the armed forces, veterans, and their surviving spouses are eligible to apply for VA loans.
- FHA loan. Unlike conventional loans, FHA loans are backed by the government and do not require a high credit score or income requirement.
- USDA loan. You can apply for a USDA loan if you live in a qualified rural or suburban area.
- Jumbo loan. Generally, jumbo loans exceed local conforming loan limits. These limits are usually $647,200, but they are higher in Alaska, Hawaii, and high-cost areas. Having more units also raises your loan limit. Jumbo loans aren’t all the same, so shop around because lenders have different standards.
Sometimes, borrowers can refinance their current loan into a different type. A lot of FHA borrowers refinance to conventional loans when they reach 20% equity. As a result, FHA loans are no longer required to have mortgage insurance. There are, however, some lenders who cannot issue all types of loans.
Ask your lender what types of loans they offer so you know your loan type. Also, find out what kinds of loans qualify for a refinance. By doing so, you will ensure you are getting the most out of your money and setting yourself up for success with your payments.
3. What types of refinances are there?
Refinancing can take several forms. In general, the following two are the most common:
- Rate-and-term refinance. In other words, your mortgage rate refers to your loan’s interest rate. It is the period during which you must make payments on your mortgage. This type of refinance changes your mortgage loan’s interest rate and term. The 15-year mortgage can be refinanced to the 30-year mortgage, for example. The monthly payment changes when you refinance your rate or term, but the principal balance remains the same.
- Cash-out refinance. You can take cash out of your home equity if you refinance with a cash-out option. Suppose you have a $100,000 principal balance on your loan and you owe $20,000 on your credit cards. Your lender would give you $20,000 in cash as part of a cash-out refinance of a $120,000 loan.
Consult your lender about refinancing options. You can then compare the advantages and disadvantages of each option.
4. What is the difference between an interest rate and an annual percentage rate?
Often, interest rate and annual percentage rate are used interchangeably. In reality, these rates are not the same.
You pay an interest rate on your loan based on a percentage. In addition to the interest rate, your annual percentage rate (APR) includes any fees and closing costs. Whenever two percentages are listed beside each other, the APR will always be higher. In other words, you should look for lenders that offer comparable loan programs at the lowest APR.
5. What will be the impact of this refinance on my monthly payment?
Your monthly mortgage payment will be affected by the refinance type you choose. Keeping your term the same and refinancing to a lower APR will reduce your monthly payment. You’ll pay less in interest over time if you refinance to a longer term, but your monthly payment will go down. Your monthly payment will increase if you refinance to a shorter term, but you’ll own your home faster.
A cash-out refinance usually increases your monthly payment. Further, if you have less than 20% equity in your property after refinancing, you may be subject to private mortgage insurance (PMI). In the event that you default on your loan, PMI insures your lender partially. If your lender requires PMI, make sure you ask them if it will increase your monthly payment.
If you are considering refinancing, ask your lender how the change will affect your monthly payment. You should be able to get an idea of how much you’ll be paying each month from your lender after reviewing your loan details.
6. What are the benefits of refinancing?
If you want to pay off high-interest-rate debt, shorten your mortgage repayment term, or reduce your monthly mortgage payment, you may want to consider refinancing.
7. Why should I consider refinancing?
It is possible to refinance your home for a variety of reasons, such as lowering your payments, paying off your home sooner, or taking cash out.
- You want to lower your monthly payments. If you refinance, you’ll be able to free up some money in your budget because your loan payment will be lower. If you refinance for a longer period, like a 30-year fixed loan, you can lower your payments. Alternatively, if you won’t be staying in your home for more than a few years, you can refinance at a lower interest rate with an adjustable-rate mortgage (ARM).
- You want to reduce your mortgage payment. By refinancing for a shorter loan term, you can pay off your home sooner and pay less interest overall. It may be possible for you to pay off your home a few years sooner if interest rates have dropped. The interest you save over the life of your loan could be thousands of dollars.
- Your home’s equity can be used to withdraw cash. To consolidate debt, make a large purchase, or make home improvements, you can refinance to take out cash. With cash-out refinancing, you receive a one-time payment from the equity in your home. Getting cash out will require a loan that is greater than the principal balance on your mortgage. Your overall mortgage debt will also increase with a cash-out refinance.
8. When refinancing my mortgage, how can I consolidate my debt?
In order to consolidate high-interest debt, homeowners can consider cash-out refinancing. Increasing your mortgage interest rate may reduce your monthly debt payments since mortgage interest rates are typically lower than credit card interest rates.
9. What is the maximum amount of equity I can cash out?
Unless there’s a really good reason, you can’t cash out 100% of your equity. It’s usually a requirement that you leave 20% equity on your house. You might have to adjust your refinancing goals because of this.
For instance, if you owned a home worth $20,000 and owed $18,000 in debt on your credit cards. In that case, you must find a lender that will allow you to cash out 90% of your equity if you wish to pay off all your credit card debt with a cash-out refinance. It may be difficult to find such lenders.
In general, if you qualify for a VA loan based on your credit score and DTI ratio, you can take out up to 100% of your equity. Get in touch with a lender to find out what their requirements are.
You can cash out some of your available equity by refinancing. Determine if the lender’s percentage is sufficient to meet your goals by comparing it to the equity in your home. If you cannot pull out enough equity to pay off your debt or fund the project you want, you might want to look for another lender or reconsider refinancing altogether. The right amount of equity can also be achieved by making a few more monthly payments.
10. Do I need to have my house appraised in order to refinance?
When refinancing your house, you will usually need an appraisal. It is possible, however, that an appraisal is not necessary depending on the circumstances. Consult your Home Lending Advisor to find out if an appraisal is necessary before you start the refinancing process.
