Mortgage refinancing involves replacing your existing mortgage with a new one that offers better terms and interest rates. This is particularly beneficial for adjustable-rate mortgages when the rate starts to increase.
For example, if you have a property with a 30-year loan at an adjustable 4% interest rate, your monthly payments can vary based on changing interest rates. By refinancing, you can convert your mortgage to a fixed-rate loan at 3%, which reduces the overall interest paid over the loan's term, resulting in lower and more predictable monthly payments. This makes budgeting much easier.
There are several ways to refinance. A common option for investors is a cash-out refinance, where you take out a mortgage for more than you owe on the property, providing you with extra cash for a down payment on another investment or to make improvements on your current property.
But first, let’s go over the basics of the refinancing process.
How Does Refinancing Work?
The refinancing process can be broken down into five main steps:
Preparation
Selecting a Lender
Rate Locking
Underwriting
Closing
Preparing for a Refinance
When preparing to refinance, your chosen lender will want to evaluate your overall financial health, including income, debts, assets, and credit scores. Documents you may need to provide include:
W2 forms
Pay stubs
Bank statements
These requirements may vary by lender. If you are self-employed, a business owner, or an investor—or a combination of these roles—be prepared to present additional documentation, such as tax returns or any leases on the property.
You should also take this time to assess the current value of your property and consider any improvements that could enhance its value. Since an appraisal is usually required to complete the refinancing process, making these enhancements now could increase your equity.
Choosing a Lender
You can choose from a variety of lenders, including banks, financial institutions, consumer finance companies, credit unions, or savings and loan firms. The key is to find a lender that offers the best terms and rates, provided you qualify.
The real challenge in selecting a lender is comparing the terms and interest rates offered. Even a slight difference in interest rates can result in significant savings over time, so it's crucial to thoroughly compare potential lenders to ensure you're getting the best deal.
Locking Your Rate
After selecting a lender and being approved for a new loan, you may have the option to lock in your interest rate. This ensures that your rate remains fixed for the duration of the refinancing process, which typically takes 15 to 60 days, depending on the lender, location, and loan type. If the loan doesn’t close within the lock period, you may need to pay a fee to extend it.
Alternatively, you can choose to “float” your rate, opting not to lock it in immediately, hoping that market rates will decrease. However, this approach also carries the risk of rates increasing.
Underwriting
Once you've submitted your documents, been approved, and locked or floated your rate, the underwriting process begins. During this stage, an underwriter thoroughly reviews your financial information.
An appraisal of your property will also be ordered. This helps the underwriter determine whether the loan amount is appropriate and assists you in evaluating your options.
For example, if you’re an investor seeking a cash-out refinance, the appraisal will help you and the underwriter determine how much extra cash you can access. If the appraisal comes in lower than the loan amount, you can opt to reduce the mortgage amount.
In some cases, you may not need an appraisal. For instance, if your conventional loan meets the Federal Housing Finance Agency (FHFA) standards for terms and underwriting, you might qualify for an appraisal waiver. The lender could use past appraisals and market estimates instead. However, if you believe your property’s value has increased since you purchased it, requesting an appraisal might be in your best interest.
The final decision on your loan is made during underwriting. You will either be approved, denied, or suspended. If suspended, the underwriter likely needs additional information. If denied, you will be provided with the reasons for the denial.
If approved, you’re ready to close.
Closing
Closing is the final step in the refinancing process. It’s usually faster than closing on a new property purchase since it avoids the need for deed transfers, inspections, and other steps involved in a typical purchase. Before closing, you'll receive a loan estimate and closing disclosure forms, which outline all the details of your loan.
During closing, you’ll sign the necessary documents to finalize your loan and pay any closing costs (typically 2% to 5% of the mortgage). The lender will disburse any funds owed to you, such as in a cash-out refinance. After that, your mortgage is officially refinanced.
Why Refinance Your Mortgage?
Refinancing isn’t always the best option. It involves costs, paperwork, and preparation, and it may not significantly impact your bottom line. However, there are several good reasons to refinance:
Lower Your Monthly Payment: The most common reason to refinance is to reduce your monthly payments over the life of the loan.
Reduce the Length of Your Mortgage: You can shorten the term of your loan, potentially paying it off faster and building equity more quickly.
Take Cash Out: Cash-out refinancing allows you to access extra funds for personal or business expenses.
Eliminate Private Mortgage Insurance (PMI): If you have more than 20% equity in your property, refinancing could allow you to remove PMI, saving you money each month.
Key Refinancing Terms
Refinancing can be complex. Two essential terms to understand are:
Discount Points: Fees paid to the lender at closing to lower your interest rate.
Amortization: The process of gradually paying off a loan through regular payments of interest and principal.
What to Consider Before Refinancing
Before deciding to refinance, consider factors such as your property's value, your credit score, debt-to-income ratio, and your long-term plans. It’s important to weigh the benefits against the costs and to ensure that refinancing aligns with your financial goals.
Types of Mortgage Refinances
There are two main types of refinances:
Rate-and-Term Refinancing: Replaces your current mortgage with a new one that has different terms and lower interest rates.
Cash-Out Refinancing: Allows you to borrow more than you owe, providing extra cash for other uses.
HELOCs (Home Equity Lines of Credit) and home equity loans are sometimes confused with refinancing but are different options based on the equity in your property.
Is Refinancing Right for You?
Refinancing might be a good option if interest rates are low, you can benefit from a lower rate, or your current loan doesn’t match your goals. However, it may not be the best choice if you’re unsure whether you’ll break even after closing costs, plan to sell soon, or if your financial situation is unstable. Always consult with professionals to make an informed decision.
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