How Does Refinancing Work?
Refinancing is the process of applying for a new mortgage with more favorable terms and/or interest rates. When you close on your new mortgage, you can pay off the old mortgage and start making payments on the new loan.
When you pull out your existing mortgage paperwork, you'll see that your monthly mortgage payment is made up of two parts: the principal and the interest. Each month, you pay a portion toward both the principal and the overall interest, plus whatever is due in taxes and insurance.
With a home refinance, you can get new terms that reduce your interest rates, lowering the total amount you’ll have to pay for your home mortgage. That can help you save big money in the long run.
Refinancing is the process of applying for a new mortgage with more favorable terms and/or interest rates.
When Is the Best Time to Refinance a Mortgage?
If you notice that mortgage interest rates have fallen anywhere from 0.5% to 1% below the current rate on your loan, you should consider a refinance.
The financial decision isn't simply reliant on interest rates, though. For a refinance to be a wise move, you'll need to run the numbers. You'll still be responsible for closing costs, which can be around 3% to 6% of the total loan. This includes a credit check, origination fees, appraisal, and other associated costs.
Do you plan on staying in your house during the time it takes for you to make up the closing costs in savings from the interest rate? If you plan to expand your family or change jobs in the next few years, refinancing may not be the best way to go. If you have no plans to move, however, and you can pay off the new mortgage faster than your current mortgage arrangement, you may want to consider refinancing.
Keep in mind that fixed-rate mortgages tend to be safer for homeowners than adjustable-rate terms. Refinancing your mortgage with a new loan that has both lower interest rates and more favorable terms could offer substantial cost-savings and help your credit score, too.
Steps in the Refinancing Process
When you're considering refinancing, you'll want to take the following steps:
- Set a goal. Whether you want to reduce your monthly payments or get rid of your FHA mortgage insurance, go into the process with a goal to achieve. That way, it's easier to compare lenders.
- Shop around for the best rates. Each lender will have different rates. Look for one that suits your needs and offers the best rates you can get.
- Limit your applications to a two-week window. This way, your credit won't be impacted by the necessary credit checks.
- Choose a lender. Compare the loan estimate, which is a document that lenders will provide after you apply. This will help you understand how much cash you'll need at closing.
- Lock in your new rate. Once you agree to a rate, it can't be changed before a certain expiration date. The goal will be to close before the rate expires.
- Get rid of the old mortgage at closing. At the closing, you will pay the closing costs, sign the new paperwork, and enjoy the benefits of meeting your financial goal.
Look for a lender that suits your needs and offers the best rates you can get.
Tips for Finding the Lowest Rates
When refinancing, you’ll have to do some legwork to find the lowest rates. Incorporate the following tips into your search.
Review your credit score.
When you apply for a new mortgage, lenders will consider your credit history. Before this happens, you should request your free annual credit report from the three credit reporting agencies.
Review your credit history closely. If there are errors regarding your payment history or debt, it can negatively impact your score. It's important to address any errors before moving forward with a refinance.
Have a consistent income.
Even with a refinance, lenders will want to see that you have had steady employment. You may need to show pay stubs or W-2s for the past few years, to prove that your income stays regular over time. During difficult economic times, some financial institutions will want to confirm your employment numerous times throughout the process.
Shop around before you commit.
Never presume that the first lender you talk to will offer the best interest rates. Approach many different financial institutions about refinancing offers, whether they’re credit unions, banks, or online lenders. Be sure you are comparing loans with similar terms. Read the fine print and ask questions.
For example, Lower not only offers competitive rates, but we also allow homeowners to access up to 95% of their equity. If your goal is to consolidate your debt and pay off high-interest credit cards, you will want to look for lenders that offer opportunities like this for making the most of your refinance.
Switch to a better mortgage plan.
Many homeowners agree to an adjustable-rate mortgage because of the initial term with low rates. However, when that term is up, you may find an unpleasant increase in your monthly payment. To benefit from the lowest interest rate, consider moving to a fixed-rate mortgage that won't fluctuate.
Many homeowners have a 30-year mortgage. See if it’s possible to refinance with a 15-year mortgage instead. You will pay your debt faster and save significantly on interest costs.
Consider paying points.
Some lenders will allow homeowners to pay upfront for “points.” One point costs 1% of the value of the loan, and can lower your interest rate by 0.125%. So, one point on a $100,000 loan would cost $1,000, but it would save you interest over the life of the loan.
Points make the most sense if you are planning on staying in your home for a while, as it can take time to make up the savings. Again, running the numbers in a mortgage calculator can help you decide if this option is viable.
Monitor rates carefully.
Not all factors that go into getting lower rates will be in your control. A lot of it has to do with the economy and the decisions of the Federal Reserve.
Though the Federal Reserve, also known as the Fed, doesn’t set mortgage interest rates directly, they do influence the rates you’ll be offered. When the Fed adjusts the federal funds rate, that impacts short-term interest rates, and banks and other lenders take notice.
When these rates are high, it costs more for banks to borrow money. Any rate increase is passed on to consumers and prospective homeowners, which can mean a bigger mortgage bill each month. You can estimate the difference by using an online mortgage calculator.
Keep an eye on economic indicators and average mortgage rates before you refinance. By just paying attention, you'll be able to track when rates are at historic lows so that you can begin the refinancing process right away.
Approach many different financial institutions about refinancing offers, whether they’re credit unions, banks, or online lenders.
Refinance Again When the Time Is Right
A home refinance is a powerful tool for improving your financial health. By understanding what you want your refinance to accomplish, you can shop around to different lenders and compare the various interest rates that are offered.
By working with the right lender, you'll be able to reduce your monthly costs, save money over the long-term, and even use your equity to pay off other debt. Many homeowners have the opportunity to save thousands by eliminating their need for private mortgage insurance or switching to a loan with more favorable terms.
While you won't want to refinance too frequently, you shouldn't hesitate to initiate the process if home prices go up significantly in your region or you find yourself able to put additional money into a down payment.
If you now qualify for a different type of mortgage than the one you got originally, it's worth exploring if refinancing can save you money and offer you additional benefits. Using a mortgage calculator and doing your due diligence will pay off for you—as you pay off your home.
Before you refinance, make sure you’re getting the best rates. Hi, we're Lower.
