For most homeowners, their home is also their most important asset. The equity you have available in your home gives you power—borrowing power, higher net worth, and even better credit. Refinancing your mortgage can save you money and also help you access that equity, but you need to understand how your mortgage and refinancing work, so you can ensure you and your home are protected.
What does refinancing mean?
In the simplest of terms, refinancing is when you take your existing home mortgage and transfer the balance into a new loan. The primary goal is usually to get more favorable, more stable, interest rates. Refinancing is especially helpful for those who take out adjustable-rate mortgages or ARMs. ARMs tend to have very low interest rates for the first three to five years. But after those 3-5 years, the interest rate skyrockets, often leaving homeowners with a loan they can’t afford. (This is a piece of what caused the financial crisis in 2008.)
Individuals can choose to refinance into different home loan options, including 15- or 30-year loans. These loans offer fixed rates. That means homeowners pay the same amount every month for 15 or 30 years until their home is paid off. Refinance mortgage rates are often more favorable to borrowers than the initial mortgage rate.
Other reasons for refinancing a home
Some other reasons people refi is to borrow from the equity in their home to fix or make upgrades on their house. This is often called a cash-out refinance. If you use a cash-out refi for home improvement, it can help with the long-term value of the home. You effectively increase the resale value of your biggest asset.
You can also use that money to pay off high-interest rate credit cards or other personal loans that could be costing you. Some people use the funds from the mortgage for other purposes, such as paying for college and making investments.
Should I refinance my home to pay off debt?
A cash-out refinance may be able to help you pay off debt, but there are many factors to consider. Most experts would recommend an unsecured debt consolidation loan first.
Tendayi Kapfidze, chief economist at LendingTree, answered this question from a Debt.com reader. Read his response here.
Benefits of refinancing
The biggest reason people refinance is that it saves them money in the long run. By reducing interest charges, you pay less money over the life of the loan. The rule of thumb that many lenders use today is that it is worth it to refinance if you will reduce your interest rate by at least 1 percent.
Years ago, the rule of thumb was reducing your interest rate by 2 percent, but rates are historically lower today than they were 25 years ago. These are some of the most popular ways that homeowners refinance:
Refinancing from a 30-year mortgage to a 15-year mortgage
The benefit that people achieve here is that their home will be paid off sooner. When people choose this option, the payments tend to be in line with what they paid on a 30-year loan. However, since the term is much shorter, total interest charges are reduced. So, you save money over the life of the loan.
Thinking of refinancing your home? Compare offers now.
Refinancing from an ARM to a fixed-rate loan
As explained earlier, ARM stands for adjustable rate mortgage. After a set time, your mortgage rate changes depending on the markets it is tied to for the year. This could quickly put a homeowner’s payments out of reach if they are on a budget. The benefit of refinancing to a fixed-rate loan is that the loan’s interest rate stays the same for the life of the loan. That means you usually don’t have to worry about sudden payment jumps, except for those caused by property tax increases.
Refinancing as a way to get a home improvement loan
While there are options to taking out a home loan, including home equity loans and HELOCs, or home equity lines of credit, refinancing allows you to retain a single mortgage, often with a better rate. This way you are getting a lower rate on all the money you are borrowing, and not just money on a home equity loan, which is essentially a second mortgage. Private loans or credit cards can also be an option when you are renovating. But again, interest rates can cause these options to become less attractive.
If interest rates are favorable, a cash-out refi can also be helpful if you have significant credit card debt and are paying steep interest fees. The additional money you receive could allow you to pay off your debts in one lump sum, with only one lower interest payment each month. If you do this, however, you must be mindful to not fall into credit card debt again, because you do not want to put your home in jeopardy.
Can I refinance my mortgage with an open insurance claim?
It depends on whether you’ve received your claim check. Your current mortgage company may need to endorse it. A Debt.com reader asked this question and was answered by Denny Ceizyk, a staff writer at LendingTree. Read his response here.
Refinancing a mortgage after a divorce
Oftentimes after a divorce, one party will get ownership of the house in the settlement. When this happens, the homeowner will usually refinance in order to make more manageable payments for themselves. It also gets the loan solely in one person’s name. It can sometimes be difficult to get a mortgage loan refi though if the individual does not have enough income or assets. Those looking to refinance after a divorce should speak with a housing professional.
Check rates and decide if it’s the right time to refinance.
How to refinance a mortgage
When you decide you want to refinance your home, you will need to visit your mortgage broker or lender. They will start the process of your refinancing and determine the amount you are eligible to refinance. After you authorize a credit check, they’ll also tell you your interest rate based on your credit and other financial factors. You will start by locking in an interest rate while you compile your necessary paperwork.
A bank must look at several financial documents during refinancing. You will also need to have your home appraised before getting approval on a refinance loan.
Note that there may be other documents, including Social Security benefit statements or proof of alimony payments. Provide all documents requested promptly to avoiding stalling out your refi.
What to expect during the underwriting process
The lender will go through all your paperwork, and likely request more as the appraisal is being completed. You will then receive final approval on your loan and final paperwork will be compiled for you to sign. There will be closing costs associated with your loan, just as with your original mortgage.
The cost to refinance will vary depending on your loan amount and the state you live in. Loan refinancing can take time, so be prepared that your refi won’t happen overnight. Your locked-in rate will guarantee that your interest rate won’t go up during this time.
Once you know your final closing costs and any potential real estate taxes, get a certified check or money order made out in that amount that can be used the day of the closing.
You will receive your final closing paperwork three business days before the actual closing. Make sure there are no last-minute changes.
On the day of the closing, you will likely have a real estate attorney present, along with the lender from the bank and any other participants, such as closing agents, who helped with your paperwork. You will sign your new mortgage or deed of trust, the promissory note and any other needed paperwork verifying the loan is yours and that you will pay it back. Your escrow account arrangements will also be finalized at this time.
Right of rescission
You usually have three business days to keep the loan if the home is your primary residence. This is known as the “right of rescission.” If you have second thoughts or feel that the terms of the loan are not what you originally agreed upon or a predatory loan, you can rescind the loan at this time and give back the money, not including closing costs.
