As a homeowner, you’ve likely seen plenty of ads trying to convince you that you’ll save money by refinancing your home mortgage. But how does home loan refinancing work? And how easy is it to refinance a mortgage? Let’s find out!
What is Home Loan Refinancing?
Home loan refinancing refers to replacing your current mortgage with a new loan. Your home refinance lender will pay off the remainder of your original mortgage, and you’ll have a new mortgage with different terms. For instance, your refinanced mortgage may have a different interest rate, monthly payment, or overall length than your original mortgage.
Depending on your situation, there are many reasons why you should refinance your home loan. You may seek to lower your monthly mortgage payments, access some of your mortgage equity, or change the terms of your mortgage loan.
Benefits of Home Loan Refinancing
The potential upsides of home refinancing loans can be significant. Benefits to homeowners can include:
- Lower interest rates
- Lower monthly payments
- Reduced mortgage term
- Access to the equity in your home
Reducing your interest rates or mortgage term can result in significant savings over your mortgage loan. This alone can make refinancing worth it in the right scenario. Accessing the equity in your home as cash can free up some of your net worth and provide you with the flexibility to make important investments or pay off other large expenses.
The benefits you’d get from refinancing your mortgage are highly dependent on your specific situation (and, to some extent, on the larger economic climate). But understanding the process and weighing the benefits against the costs will help you determine if it’s the right move for you.
How Does Home Loan Refinancing Work?
Applying for a home mortgage refinance loan isn’t all that different from the mortgage application process. Here are some things you’ll want to remember as you consider whether a home loan refinance suits your situation.
Eligibility Criteria for Refinancing
Every lender maintains their own eligibility criteria for home loan refinancing. These criteria generally include the following:
- Credit Score: Most home loan refinancers require a minimum credit score between 580 and 620. However, certain federal loan programs have lower requirements. For instance, the Federal Housing Administration (FHA) provides refinancing options for homeowners with credit scores as low as 500.
- Home Equity: This refers to the amount of your home you own. You can calculate your equity by comparing its current value to the amount you still owe on your original mortgage. You’ll likely need at least 20% equity in your home to be eligible for the best refinancing terms.
- Debt-to-income (DTI) ratio: Many lenders will consider the amount of overall debt you have compared to your income. Borrowers with large amounts of credit card or other debt may find it harder to be approved for a mortgage refinance.
- Original mortgage in good standing: You’ll need to be up-to-date on the payments for your current mortgage to be eligible for a refinance.
- Cash for closing costs: Generally speaking, you’ll need to be able to access enough cash to cover the fees and closing costs on your refinanced mortgage (more on this below). Some lenders may allow you to fold the costs of your refinance into the loan principal itself.
Calculating Your Home Loan Refinance Costs
The cost of your home refinancing loan will depend on several factors, including the size of your loan and your qualifications as a borrower. You will likely be responsible for lender fees, appraisal costs, taxes, and title fees. For simplicity’s sake, these are often combined and referred to as “closing costs.”
Determining the potential costs of your mortgage refinance is crucial in deciding whether refinancing is right for you. Comparing these costs to the benefits you’ll get from the new loan will help determine whether a refinance financially benefits you. For instance, if your new loan terms will save you $100 monthly and your refinancing costs come to $3,000, it will take 30 months to recoup them.
Many lenders offer refinance calculators to help you understand what your home loan refinance costs are likely to be. Generally speaking, home loan refinance costs fall somewhere between 2% to 6% of the total loan amount.
Applying for a Home Loan Refinance
A crucial part of the home loan refinance process is exploring the offerings from multiple different mortgage lenders. You’ll want to compare the terms each lender offers you and the costs associated with each loan.
Depending on your credit score, you can often be pre-approved for a mortgage refinance without submitting a full application. This means you can get a sense of the offers that will be available to you without undergoing a hard credit inquiry, which is valuable since every hard credit inquiry can potentially lower your credit score.
Gathering Required Documents
Your refinance lender will require some documents to process your new loan. Having these in order will make the process go more smoothly. Among the documents you’ll likely need to put together are:
- Tax returns for the past several years
- Pay stubs or other documentation of income
- Bank statements
- Other asset statements (from retirement or investment accounts)
- Documentation of homeowner’s insurance
- Documentation that your current mortgage is up-to-date
Home Appraisal Process
Outside of an FHA streamlined refinance, nearly every home loan refinance will require an appraisal of your home’s value. Determining the updated worth of your home is a crucial part of the process since that value will impact your loan-to-value ratio (the value of your property compared to the outstanding balance on your original mortgage).
Since it’s in your interest to have your home valued as highly as possible, you’ll want to prepare for the appraisal by ensuring it looks its best. If you’ve been putting off minor repairs or upgrades, now is the time to finish them! Ensure you let the appraiser know of all the upgrades you’ve made to the home since the last time it was appraised.
Closing on the New Loan
Once you’ve completed the home appraisal process, your lender will be able to finalize all your loan details. Before your actual closing date, you’ll be presented with closing documents that show the finalized terms of your loan and lay out all closing costs. Review this paperwork carefully to ensure it matches your understanding and expectation of the loan terms.
When the closing date arrives, you’ll physically sign all of your loan paperwork, likely in the presence of a closing agent. Once you sign on the dotted line, you’ll have a new mortgage.
Factors to Consider Before Refinancing
Determining whether a home loan refinance is right for you depends on various factors, some of which are within your control and others impacted by external forces.
Current Interest Rates
Many people choose to refinance their mortgages when interest rates are low. If you can lock in a lower interest rate than you’re paying on your current mortgage, that will very likely save you money over the loan.
For example, imagine that your original mortgage is an adjustable-rate mortgage (meaning that the interest you’re paying changes with prevailing interest rates). When market interest rates are particularly low, you may be able to benefit by getting a home loan refinance and changing your terms to a fixed rate.
Length of Mortgage
The length of your original mortgage is one of the primary things to consider when deciding whether it’s worth refinancing. A longer mortgage term can mean lower monthly payments but higher total interest payments over the course of the loan. A shorter mortgage term means you’ll save on interest over the life of the loan, but these savings likely mean higher monthly payments in the short term.
Many homeowners use the home loan refinance process as a way to change the overall length of the mortgage.
Your Credit Score
Your credit score will impact the quality of the home refinance terms you’re offered. A high credit score means that refinance lenders will consider you less of a risk to default on a loan. This means they’ll likely be willing to offer you better terms – including more favorable interest rates.
Improving your credit score takes work, but it is possible to accomplish by making timely payments, keeping your debt ratio low, and limiting applications for new accounts. If your credit score is on the lower end, it may be worth it to work at improving your score before applying to refinance your home.
Closing Costs
Closing costs can encompass everything from lender fees to appraisal costs to escrow and title fees. These costs will constitute a large portion of your cash outlay during a home refinance, so it’s crucial to understand how much they’re likely to total.
Although there’s no one formula to determine closing costs, lenders often estimate that they will range between 2% and 6% of your principal loan amount. If you’re considering a home refinance, you’ll need to have enough cash on hand to cover these costs. You’ll also want to work with a lender who is as transparent as possible about what your final costs will likely amount to.
How to Choose the Best Mortgage Lender for Your Needs
As with any type of loan or financial product, you’ll have a variety of options. Different mortgage lenders will be able to provide access to different terms for your refinance loan. For example, some may charge a flat fee for closing costs, while others charge a percentage of the loan value; which works better will be highly dependent on your individual circumstances.
You’ll likely get the best deal if you’re willing to put some time into comparing offers from several different refinance lenders. This doesn’t mean you need to fill out multiple full applications (and you probably shouldn’t, to protect against too many hard credit checks). But it does mean you should investigate several lenders, particularly those that offer pre-approval processes, to get a sense of the terms they might be able to offer you.
Tips for Successfully Navigating the Home Loan Refinance Process
1. Understand Your Situation
Find out what the loan-to-value ratio on your current mortgage is, understand how the interest rates you’re paying on your loan compare to current market rates and take some time to think about your long-term financial goals
2. Understand the Marketplace
Do some research on potential lenders. Read customer reviews, talk to family members or coworkers in similar situations, and ask questions about different lenders. If you can’t get a transparent answer from a lender, that’s probably not a good sign.
3. Talk to an Expert
Having someone who knows the ropes of home loan refinancing (and has your best interests in mind) can make the process simpler and more successful. Rob’s Mortgage Loans has served Colorado homebuyers and homeowners for 30 years. I can help you understand how mortgage refinance works and your potential refinancing options so that you’re making the most informed choice possible. I always aim to get you the best mortgage aligned with your needs.