If you have a mortgage, or other type of loan with a high interest rate a refinance can lower your rate and monthly payments .
If you’ve never refinanced before there are some things you need to consider.
This mortgage refinance guide will teach you everything you need to know about how to refinance your mortgage, get the best rates, and the pros and cons of refinancing.
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What does it mean to Refinance a Loan?
Refinancing is takes your current mortgage loan and refinances it with a lender, either a new or current lender for a lower interest rate or monthly mortgage payment. The entire mortgage refinance process takes 46 days to close on average according to Fannie Mae.
Pros and Cons of Refinancing
- Lower your interest rate
- Pay off your loan faster
- Lower your mortgage payment
- Save money on interest
- Get a 15 or 30 year fixed rate loan
- Remove mortgage insurance
- Closing costs can be as high as a new mortgage
- Can extend the term of your loan
- Requires lots of paperwork
- It’s not a quick process
The Cost of Refinancing
When you refinance your mortgage loan it’s not free. Typically you will pay closing costs between 1%-3% of the loan amount.
Use a home refinance calculator to figure out if you will save enough money after the refinance fees to justify it.
Costs associated with refinancing
- Mortgage application fee – The application fee can be as high as $250. Some lenders may waive this fee.
- Home appraisal fee – The home appraisal fee is required prior to close and is paid by the buyer. On average this fee is between $300-$500.
- Loan origination – The loan origination fee is the largest fee involved when you refinance. It is usually between 1% – 3% depending on your credit score, loan balance, lender, etc.
- Title search and insurance – The lender will do a title search to ensure you are legally able to refinance the loan.
The No-Cost Refinance
You might have heard of a no closing cost refinance at some point. In some cases this is just a marketing ploy and the costs are just presented in another form such as, higher rates or other fees.
Be sure to get a complete break down of all the additional costs associated with the loan before accepting the offer.
When to Refinance Your Mortgage Loan
There are several different reasons you may have to refinance your mortgage. Maybe you just need a lower payment by re-amortizing your loan. Or you want to take advantage of the all-time low interest rates of today.
- Switch to a new loan term, adjustable-rate to fixed-rate mortgage
- Change the length of your mortgage, 10yr, 15yr, 30yr
- Lower your mortgage rate
- Use home equity to get cash back
- Pay off high interest debt
- Make home repairs and renovations
- Remove cosigner
- Reduce your monthly mortgage payment
- You’re underwater on your mortgage
- Remove private mortgage insurance (PMI)
How to Get Lower Refinance Rates
When refinancing you want to make sure you get the lowest interest rate possible to save you the most money. There are a few things you can do to ensure you’re getting the best rates.
Compare Multiple Loan Offers
When refinancing your mortgage, auto loan, or any other type of loan it’s very important to not settle with the first lender you speak to.
You should always shop rate quotes from multiple lenders. Remember, there is more than just rates to look at. There are refinance fees and closing costs. All of these costs can be negotiated and getting quotes from at least 3-4 lenders can help you get the best deal.
You can use the quotes to help your negotiating power with each mortgage company.
Buy Discount Points
Points are pre-paid interest on a loan. This is also called “buying down the rate”. Borrowers can buy up to 4 points, the more points you buy the lower your your interest rate and monthly payment will be. One point will cost 1 percent of the loan amount ($1,000 for every $100,000).
Increase Your Credit Score
Your credit rating is directly tied to the interest rate you receive on a loan. The higher your FICO score, the lower your rate. Before applying to refinance your mortgage loan you want to ensure your credit score is as high as possible. Here are a few tips.
Pay down your credit card balances
Your credit utilization ratio is the amount of available credit you have used up. This ratio accounts for 30% of your overall credit score, only your payment history (35%) has a bigger impact on your score.
The lower your credit card balances, the higher your score will be. Try to get your balances under 10-15% of the of their credit limit in order to maximize your credit scores.
Don’t open any new credit or loan accounts
When you attempt to open up any new credit lines or loans your FICO rating will decrease. Each time you apply for credit you’re adding a new credit inquiry onto your credit history which can lower your score.
New accounts also make up 10% of your credit score. Having recently opened accounts shows you are actively looking for credit and loans and is a sign of financial distress.
Have someone add you as an authorized user
An authorized user is a second person added to a credit card account that is able to use a card. You don’t actually have to have a card of your own to be an authorized user.
If you know anyone that has a credit card account in good standing, and preferably has been opened for a long time it will help your credit score.
Refinance to Remove Mortgage Insurance
Private mortgage insurance (PMI) is an annual fee of 0.50% – 1% of the loan amount of your mortgage you pay with a down payment less than 20% of the purchase price. If you have a conventional loan PMI will automatically be removed when your loan-to-value ratio on your loan reaches 78%.
If you have an FHA loan then in most cases you will have to pay MIP, mortgage insurance premium for the life of the loan if you put less than 10% down. With a 10% down payment FHA requires MIP for the first 13 years.
However, if the LTV ratio on your FHA mortgage is under 78% you can refinance out of FHA into a conventional mortgage to remove mortgage insurance. This is commonly done by homeowners, removing mortgage insurance can save you thousands of dollars per year.
Credit Score Needed to Refinance
In order to refinance your mortgage you’ll need to meet the lenders minimum requirements. For most types of refinance loans you’ll need to have at least a 620 credit score. Some lenders may be able to work with slightly lower FICO scores in some cases.
Fixed-Rate and Adjustable-Rate Mortgage Loans
The 15 year fixed-rate mortgage is being more popular today as people are trying to have their mortgage paid off sooner. If you have a 30-year rate you could save tens of thousands of dollars in interest and have your home paid off much sooner with a 15 year loan.
15 yr fixed-rate mortgage loans come with a lower rate than a 30 yr loan. Your monthly payment will be higher with a 15-year mortgage so you will need to make sure your debt-to-income ratio is under 41% in order to qualify.
If you do not want to commit to the higher 15 yr mortgage payment. You can get a longer term loan and just make extra payments to pay off your mortgage quicker. There is no prepayment penalty for mortgages.
If you have an adjustable rate mortgage you will have a low interest rate for the first 5 years of the loan. After the initial low rate period the rate will increase annually. So it may be time for you to refinance your adjustable rate into a fixed rate mortgage.
Refinancing to Remove a Co-Signer
If you used a co-signer or co-borrower to help you qualify for your mortgage you can remove them by refinancing. A co-signer release is when you remove the co-signer from the mortgage making you fully responsible for repaying the loan.
Types of Refinance Loans Available
You may be surprised to know that there are many types of refinance loans available. Regardless of your reason to refinance there is a loan program designed for you. These are the difference types of home refinance loans available.
Rate and Term Refinance
Rate and term refinancing is a traditional refinance that will lower your mortgage rate and re-mortizize your mortgage loan. This is for borrowers with a conventional loan who want to lower their mortgage payments and get a lower rate.
There are several different mortgage terms you can refinancing into. 15 year and 30 year fixed-rate loans, and adjustable-rate loans. You may also choose this type of loan in order to remove PMI. If you have a loan-to-value ratio less than 78% then PMI can be removed saving you up to 1% of the loan amount each year.
If you have a Government backed mortgage loan such as an FHA loan, VA loan, or USDA loan then you may qualify for a streamline refinance. Streamline means the process is quicker and easier than a traditional refinance.
There is little documentation needed. Some lenders may not even require a credit check allowing you to get a streamline refinance with bad credit. However, usually you need a 620 credit score to qualify. Income is not verified and you can be underwater on your mortgage. Being under water means you owe more on your home than it’s current market value.
The FHA streamline refinance is the most popular type of loan used. While these refinances are quick and easy they still have closing costs than can equate to thousands of dollars.
Home Affordable Refinance Program
HARP was created after the 2008 housing market crash by the Obama Administration in 2010. When millions of property values were dropping and many people were underwater on their mortgage and unable to refinance.
In an effort to slow foreclosures HARP was introduced allowing borrowers who were underwater the chance to refinance their mortgage and receive a lower rate and monthly payment. Specifically helping homeowners who had a loan-to-value ratio above 100%.
The HARP program is set to expire at the end of 2018. When HARP expires two programs will replace it. The Freddie Mac Enhanced Relief Refinance and Fannie Mae’s High Loan-to-Value Refinance Option. Both of these programs will allow borrowers to refinance with having less than a 5% equity stake in their home.
Refinancing to Get Cash Out of Your Home
If you have some equity built up in your home you can tap into that equity to pull cash out. You will usually need a minimum of 70% LTV ratio. These refinance options will allow you to borrow up to 75% – 80% of the market value of your home.
Home Equity Loans
Home equity loans are also known as a second mortgage because it is an additional loan on your home and the lender will take a second lien holder position on your property.
If you were to ever default on your loans and the property foreclosed on the first lien hold gets paid first and the second lien holder gets what’s left.
Because it is a bit more risky for the lender you will receive an interest rate that is higher than current mortgage rates. Getting a home equity loan or HELOC with poor credit is difficult.
You will be provided with a lump sum payment that you may do with as your please. Typically used to make improvement or repairs to a property. They can be used for debt consolidation or to make other large purchases such as, a new car or vacation.
Home Equity Line of Credit
A home equity line of credit is very similar to a home equity loan. They work more like a credit card than a loan. With a HELOC you will receive a credit line that you can borrow from on an as needed basis.
The benefit of line of credit is that you are only charged interest on the amount you borrow. When you pay it back you are no longer charged interest and can borrow more at a later date.
Home Equity Loans and HELOC Pros and Cons
- Use equity to get cash
- Make repairs or renovations to your home
- Lower interest rate than personal loans
- Pay off high interest debt like credit cards
- Reduces the amount of equity your have
- Interest rate is higher than mortgage rates
- If unable to repay the loan your home is at risk of foreclosure
A cash-out refinance is where you take your current loan and refinance it and get additional cash for equity up to a 80% LTV. However, unlike home equity loans it is not a second mortgage.
The lender will buy out what you owe plus give you cash back. This way they are the first and only lien holder making the loan less risky allowing them to give you a competitive interest rate. Also, cash-out refinancing is easier to get if you have credit issues than a home equity loan.
The major benefit is that the additional cash you receive will be at the same low rate that you get on your mortgage. With interest rate at all time lows, this will be the cheapest way to get a loan for personal use.
The Bottom Line…
A mortgage refinance doesn’t have to be a difficult process. In this guide we’ve given you all the basics of mortgage refinancing. Remember the key to refinancing is getting the best interest rate possible.
Shop at least 3-4 lenders, maximize your credit score, and know which loan term and type of refinance is best for you.
DO you think you’re ready to refinance?
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Randall has over 15 years of experience in the mortgage and credit industries. He spends a chunk of time helping consumers understand their credit, advise them on how to increase their credit, and lending his mortgage expertise to help them find the right type of loan. Randall lives in Dallas, Texas with his two sons.