What Is Refinancing?
Refinancing is the process of replacing an existing mortgage with a new loan. Typically, people refinance their mortgage in order to reduce their monthly payments, lower their interest rate, or change their loan program from an adjustable rate mortgage (ARM) to a fixed-rate mortgage. Additionally, some people need access to cash in order to fund home renovation projects or paying off various debts, and will leverage the equity in their house to obtain a cash-out refinance.
Regardless of your goal, the actual process of refinancing works much in the same way as when you applied for your first mortgage: you'll need to take the time to research your loan options, collect the right financial documents and submit a mortgage refinancing application before you can be approved.
What Is the Process for Refinancing Mortgage Loans?
How does refinancing work? Although it’s usually less complicated and time consuming than the initial home buying process, refinancing your mortgage still follows a similar set of steps:
Application
During the refinancing application process, your first step should be to determine what type of refinancing will best fit your needs. Once you’ve made your decision, you will need to provide your lender with documentation relevant to your loan, including paystubs, W2s and bank statements. Your lender will also use information related to your assets, income and credit score to determine the risk associated with offering you a loan. If you meet the loan requirements, the application can go through.
Mortgage Rate Lock Option
Mortgage interest rates are extremely dynamic, and may change from day to day. After finalizing your application and getting approved for your loan, your lender may give you the option to lock your rates so they don’t change before you close on the loan. Typically, you’ll have the option to lock your rates for a period of 30, 45 or 60 days, with the option to extend the rate-lock period for additional fees. Alternatively, you may choose to ‘float’ your rate rather than locking it in, accepting whatever mortgage rates may be at the time of closing.
Underwriting
With your application submitted and your rates locked-in or floating, the lender must then review and verify your information. This underwriting process will also include a home appraisal, where a licensed appraiser will visit your property to create an estimate of its current value. The value of your property will help determine the limit of your loan. We recommend having a list on hand with any upgrades you may have made to the property during homeownership.
Closing
The final stage in the process is to close on the new loan. The lender will create and share with you a Closing Disclosure (CD) document detailing the important information and costs relevant to the loan. This includes loan fees, real estate taxes, the amount financed, annual interest percentage rate, finance charge and payment schedule. When you close, you will meet with the lender to go over the details, sign the loan documents and settle on any additional costs that are not included in the closing costs. Although closing may feel final, you will still have a short, three-day grace period after closing during which you can back out of the refinance if you need to.
Reasons to Refinance
There are several reasons to refinance your mortgage. Some of the potential advantages include:
- Lowering your monthly payment*. According to one study, an average homeowner may save $160 or more per month with a refinance. With a lower monthly payment, you are free to put the savings toward other debts and other expenditures, or apply that savings towards your monthly mortgage payment and pay off your loan sooner.
- Remove private mortgage insurance (PMI). Some homeowners who have enough property appreciation or principal paid off will not be required to pay mortgage insurance which will reduce your total monthly payment.
- Reducing the length of your loan. For homeowners who took out a mortgage in the early stages of their career, a 30-year mortgage may have made the most financial sense. But for those who want to pay off their mortgage sooner, reducing the loan term can be an attractive option.
- Switching from an adjustable-rate mortgage to a fixed-rate loan. When you have an adjustable-rate mortgage, your payment can adjust up or down as interest rates change. Switching to a fixed-rate loan with reliable and stable monthly payments can give homeowners the security of knowing that their payment will never change.
- Consolidating your first mortgage and your home equity line of credit (HELOC). By rolling these into a single monthly payment, you can simplify your finances and focus on one debt. HELOCs often have adjustable rates, so refinancing into a fixed-rate loan could potentially save you money in the long run.
- Using the equity in your home to take out cash. With rising home values, you may have enough equity to take out a cash-out refinance. This money can be used to finance home improvements, pay off debts or to fund large purchases.
Risks of Loan Refinancing
Depending on your goals and financial situation, refinancing mortgage loans may not always be your best option. While refinancing offers many benefits, you’ll also have to weigh the risks.
For example, refinancing your mortgage usually restarts the amortization process. So, if you are five years into paying on a 30-year loan and you decide to take out a new 30-year mortgage, you’ll be making mortgage payments for 35 years. This is a good plan for some homeowners, but if you’re already 10 or 20 years into your mortgage, then the lifetime interest may not be worth the extra costs. In these instances, many homeowners refinance into a shorter-term loan that won’t extend the time they will make mortgage payments, such as a 20 or 15 year mortgage (which oftentimes offer lower rates than 30-year loans).
Generally, refinancing is a good option if the new interest rate is lower than the interest rate on your current mortgage, and the total savings amount outweighs the cost to refinance. For example, if you have $390,000 remaining on a $400,000 loan at 4.25%, replacing your existing mortgage at 3.75% can earn savings of $162 per month compared to your previous loan.*
Use our mortgage calculators to estimate what your new monthly mortgage payments might be.
*By refinancing your existing loan, your total finance charges may be higher over the life of the loan.
