What Are My Options for Refinancing?
When you refinance your mortgage, the lender replaces your existing home loan with a new loan that has new terms. The lender, interest rate, number of years for repayment, and the amount you’re financing can all change.
There are three main options for refinancing your mortgage.
Rate-and-term refinance
Rate-and-term refinances are the most common mortgage refinancing arrangements.
In a rate-and-term home refinance, the lender can assign a new interest rate and loan term. For example, the lender could pay off your 30-year fixed-rate mortgage and create a new loan with a 15-year fixed rate. Or, you could get a new loan with the same 30-year repayment period but a new interest rate.
In a “no cash-out” refinance, the closing costs associated with the loan can be added to the loan balance to avoid out-of-pocket expenses.
Cash-out refinance
If you’ve earned equity on your property by paying off a portion of your mortgage, you can apply for a cash-out home refinance. Like a rate-and-term refinance, the rate and loan length can change during a cash-out refinance.
This type of home refinance involves taking out a new loan that is at least 5% larger than the original mortgage balance. The lender then passes the surplus funds on to you. Lenders usually limit the amount of cash that you can “take out” to around 80% of the home's appraised value.
Cash-out refinances can result in a cash payment paid directly to the buyer, or in the case of a debt consolidation refinance, directly to creditors. With a debt-consolidation refinance, you can use your home’s equity to pay down credit card debt, student loans, and other debts. You can also take out a cash-out mortgage to consolidate first and second mortgages.
Because cash-out mortgages are riskier than rate-and-term refinance mortgages, lenders usually have stricter standards. That means you may need a higher credit score and you may have to take out a smaller loan than you would otherwise.
Cash-in refinance
A cash-in refinance, as you might expect, is the opposite of a cash-out refinance. Here, you pay down your original mortgage and refinance a new mortgage based on the balance. Cash-in mortgage refinances can offer a lower interest rate, a shorter loan term, or both.
A cash-in home refinance may be a good option if, for example, you’re looking to lower your rates or decrease your loan-to-value (LTV) total. When borrowers have an LTV of 80% or higher, they pay a mortgage insurance premium each month. Refinancing at a lower LTV can remove this premium and save you money each month.
When you refinance, the lender, interest rate, number of years for repayment, and the amount you’re financing can all change.
How Does the Application Process Work?
Different refinance loans have different requirements. Usually though, lenders will look at similar criteria for a refinance as they do for a first mortgage, including:
- Credit scores and mortgage payment history
- Debt-to-income ratio
- Income and employment history
- Assets and cash reserves
- Results of a home appraisal
Home refinance applications usually require less documentation than a first mortgage. Paperwork you can expect to produce for a refinance loan application includes:
- Current mortgage payment record for the past several months, if you’re switching lenders
- Proof of income in the form of W-2s and pay stubs
- Bank statements to prove asset value
- Proof of citizenship or US residency status
Some types of refinancing won’t require these forms of documentation. If you opt for a “streamlined” refinance, you may not need to provide any verification in terms of assets or income. Popular streamlined refinancing programs include those designed for government-insured loans like FHA, VA, and USDA loans.
In general, refinancing often has a short closing time — 30 days is common, or even less with a streamlined refinance program. However, when you’re going through the process, keep making your monthly mortgage payment. You may receive a refund after the refinance goes through, but this is a better outcome than risking a late fee that could blemish your credit.
Benefits of Refinancing
Refinancing ads from banks and other lenders make bold claims about saving homeowners thousands of dollars and putting cash in their pockets, but it’s essential to evaluate your unique circumstances.
If you refinance your mortgage at the right time, it can provide several attractive benefits.
Lower mortgage rate
If you plan to stay in your home for several years, lowering your mortgage rate by just 1% can save you a substantial amount of money. Even a 0.5% rate reduction may be worthwhile if you plan to stay in your home long-term.
Reduced monthly mortgage payments
Take a look at savings beyond the lowered rate, too. If you’re able to get rid of your mortgage insurance premiums, refinancing at only a slightly lower rate may be worthwhile. You can also add more consistency to your budget by switching to a fixed-rate loan.
By refinancing once you’ve improved your financial standing and applying for a mortgage with more predictable payments, you could wind up paying less.
Eliminating high-interest debt
When you refinance to a new loan that allows you to make reduced monthly mortgage payments, you can use those savings to reduce or prevent high-interest debts. Paying for college with a home refinance, for example, may help you avoid high interest rates charged by traditional student loan providers.
Fund home improvement projects
Using a cash-out refinance to fund an expensive home improvement can help you earn money when you sell your home. Improvements like updated kitchens, new patios, and extra rooms can significantly increase your home’s resale value.
Own your home sooner
When you refinance to a shorter loan period, you’ll own your home sooner. If you can afford to make larger payments, you’ll even save on interest along the way.
Get peace of mind with a trustworthy lender
Occasionally, homeowners have issues with their lenders so significant that it’s worth the hassle of refinancing to move to a new lender. If you haven’t been satisfied with the lender providing your initial mortgage, this is a great opportunity to find one that’s better suited to your needs.
If you refinance your mortgage at the right time, it can provide several attractive benefits.
Drawbacks of Refinancing
When it’s not the right time, refinancing can create several issues for homeowners.
Costs may be greater than potential savings
Because you’re taking out a new mortgage to pay off your first mortgage, you’ll incur closing costs like you did the first time.
You’ll also have to pay origination fees, title insurance, and application fees. You might also need to pay for a new appraisal to establish the amount of equity you have available.
Overall, you can expect to pay between 2% and 6% of the amount borrowed. Do some quick math (or use an online refinance calculator) to make sure you’re saving enough through the refinancing to make the transaction worthwhile.
Longer-term loans can cost more over time
While you could lower your monthly payment by refinancing your 15-year mortgage to a new 30-year mortgage, you may wind up paying more for your home in the end. Compounding interest over the additional years could overtake your potential savings.
In this situation, unless you need to adjust your monthly payment to meet other obligations, it’s better to choose a new loan term similar to the one you have on your original mortgage. You’ll likely get a lower mortgage rate for a shorter-term loan, and you can often pay off your loan faster without increasing your monthly payment.
“No-cost” refinance offers can be costly
Lenders sometimes offer refinance deals with no closing costs, but with a higher mortgage rate. Over time, the higher interest rate adds up. If you’re planning to move within a few years and need cash, a no-cost home refinance can be a good move, but keep in mind that if an offer sounds too good to be true, it probably is.
New terms mean new budget requirements
Switching from a 30-year to a 15-year mortgage can indeed save you a great deal of money. You’ll enjoy a lower interest rate and reach your payoff date twice as fast.
However, your monthly payment will be significantly higher, so it’s important to consider your budget carefully. Don’t take on a higher payment than you can realistically afford.
Consider the costs of a refinance carefully, or you may wind up paying more for your home in the end.
Calculating the Cost-Benefit Ratio of a Refinance
One of your goals with a refinance should be to recover your closing costs in a reasonable time. A good rule of thumb is to try to wait until you can save at least a full percentage point on your current mortgage rate.
To calculate how long it will take your cost savings to exceed the cost to close your new mortgage (the “break-even point”), you can use an online refinance break-even calculator. These tools can help you determine if you’re likely to stay in the home long enough to make a refinance worth the trouble and cost.
However, sometimes borrowers refinance to gain benefits other than those directly related to cost savings. For example, if you use a cash-out refinance to pay down debt with high interest, you could save thousands of dollars that you would have paid toward those debts over a more extended period.
A good rule of thumb is to wait to refinance until you can save at least a full percentage point on your current mortgage rate.
10 Tips for a Successful Mortgage Refinance
To get the best results from your home refinance, keep these tips in mind:
- Use a break-even calculator to make sure the refinance is cost-efficient.
- Read reviews and ask for recommendations if you’re refinancing with a new lender.
- Ask for advice about which kind of refinance is best for your situation.
- Get rate quotes from multiple lenders.
- Gather your paperwork early in the process in case you need to request any documents.
- Make sure you understand closing costs and other fees.
- Keep making your monthly mortgage payment until the refinance is complete.
- Aim for a rate reduction of at least a full percentage point.
- Look beyond the interest rate to other benefits and drawbacks of a refinancing offer.
- Check your credit reports well ahead of time and fix any errors.
Ready to Refi?
If you decide refinancing is right for you, you’ll want to do a few things first.
Start by identifying your goals for the refinance. Then, shop around to make sure you’ve got the best rate available. As you evaluate your options, prepare your home for appraisal and your credit history for review to make the process as quick and painless as possible,
Refinancing your home loan can be a smart financial move, but it’s important to evaluate your current situation carefully before moving forward. Refinancing to less attractive terms can be costly, and may wind up hurting more than it helps.
Ready to get started on your refinance? Hi, we're Lower. We can help you choose the right refinance option. Check out our current refinance rates.
