What is Mortgage Refinancing?
When you apply to refinance your home loan, you are essentially attempting to pay off your existing mortgage and replace it with a new one. The new loan pays off the remaining balance of the former loan, and after closing, you begin making payments on the new loan’s principal, interest rate, and terms.
Why Do Homeowners Refinance?
Refinances are not required, but they can significantly improve your financial stability and future. The decision to refinance is typically driven by a desire to improve or secure a family’s financial future, primarily through these goals:
- Lowering Your Interest Rate (Rate-and-Term Refinance): Securing a lower rate can reduce your monthly payment and the total interest paid over the life of the loan.
- Shortening the Loan Term (Rate-and-Term Refinance): Switching from a 30-year to a 15-year term can save you substantial interest and help you build equity faster.
- Using Home Equity (Cash-Out Refinance): A Cash-Out Refinance allows you to tap into the equity you’ve built to fund a large purchase, pay for home renovations, or finance college tuition.
- Consolidating Debt (Cash-Out Refinance): Using a cash-out refinance to pay off higher-interest debt (like credit cards or personal loans) can lower your monthly outflows and simplify your finances.
- Eliminating Private Mortgage Insurance (PMI): If your home’s new appraised value confirms you have at least 20% equity, refinancing your conventional loan can allow you to drop the costly Private Mortgage Insurance (PMI), immediately lowering your monthly bill.
When Does Refinancing Make Sense?
Refinancing involves costs, so it’s essential to determine if the long-term savings outweigh the upfront fees.
Calculating the Break-Even Point
A key step in determining if refinancing is worth it is calculating your break-even point. This is the amount of time if will take for your monthly savings to cover your closing costs.
Break-Even Point (Months) = Total Refinance Closing Costs / Monthly Savings from New Payment
If you’re planning to stay in the home longer than the calculated break-even period, refinancing is generally a financially sound decision.
Market Rate Conditions
Generally, a good time to consider refinancing is when current interest rates are at least 0.5% to 1.0% lower than your existing rate.
The Costs of Refinancing
Unlike when you purchase a home, you don’t need a down payment for a refinance. However, you will incur closing costs similar to those in the buying process. These fees typically range from 2% to 5% of the loan amount and cover expenses such as:
- Lender Origination Fees
- Appraisal Fees
- Title Insurance and Searches
- Attorney Fees
You typically have two options for handling these costs:
- Pay Cash Upfront: Paying the closing costs out-of-pocket keeps your new loan principal lower.
- Roll Costs into the Loan: You can finance the closing costs into the new mortgage. This means you pay less cash upfront, but your monthly payments and total interest paid will be slightly higher.
How the Refinance Process Compares to Buying a Home
The primary difference you will notice is that since you are already the homeowner, the refinance process is generally simpler. There are no real estate agents, no purchase contracts, and no down payment to worry about.
However, much of the loan process will feel familiar to when you purchased your home:
- Application & Evaluation: Your credit score and income will be evaluated. You will complete a new loan application with a Loan Officer, and a team of underwriters will review your financial profile.
- Property Appraisal: Most types of refinance loans require a property appraisal. This ensures the lender verifies that the home’s value is sufficient to secure the amount being loaned.
Preparing for a Smooth Refinance
To make your refinance process go as smoothly as possible, preparation is key.
- Gather Financial Documents
Assemble your financial documents in advance. You will likely be asked to provide:
- Tax Documents: Your W2s and/or tax returns from the past two years.
- Pay Stubs: Your most recent pay stubs.
- Bank Statements: Your most recent bank statements.
- Protect Your Credit Score
Your credit score directly impacts the interest rate lenders can offer you. If you are uncertain of your credit score or think it needs improvement, contact your Loan Officer before you apply.
- Review Your Home’s Value
Since the appraised value of your home can directly influence the rate a lender offers, it is in your best interest to ensure your property is in good shape. Also, verify that any major additions or renovations made since purchasing were properly permitted by your city.
Southern Trust Mortgage has been helping clients buy and refinance properties since 1998. Our loan officers are knowledgeable in all aspects of how a home loan refinance can benefit you. Ready to see if refinancing is right for you? Contact us today to discuss your financial goals.
