Refinancing Your Mortgage

Refinancing Explained

Refinancing your mortgage entails paying off your original home loan by replacing it with a new loan featuring different terms. Many homeowners do this in order to lower their monthly payments, which can be done in a number of different ways – some of which offer better long-term benefits than others.

In some cases, you might qualify for a lower loan rate. This could serve you well in a couple of different ways. First, a lower rate can decrease your monthly mortgage payment, allowing you to divert that money elsewhere in your budget or savings plan. Next, you’ll pay less money in interest over time. Over the course of a 30-year mortgage, that adds up to a lot of savings.

Another way to get a lower monthly payment is by extending your loan term. For example, say you bought your house five years ago with a 30-year mortgage; you’re now down to just 25 years of payments left. You could refinance your mortgage to start over at 30 years.

You now have a lower loan amount after five years of payments, and by stretching it out over a longer period, you’ll reduce those payments each month. On the downside, you’ll end up paying more money in interest over the long run.

Closing Costs

Just like a regular mortgage, you’ll have to pay closing costs to your lender as part of a refinance. When calculating your potential savings with a refinance, you need to consider these extra costs.

Saving $40 a month may not feel like a lot compared to a few thousand dollars you may pay at closing.

If you plan on staying in your house for a long time, however, even small monthly savings may be worth it. Figure out when you’d break even on your costs vs. savings, then see if you picture yourself in the home at that point in your life.

Cashout Refinance

In addition to refinancing with the purpose of changing your monthly payment, you can also apply for a cashout refinance if you have enough equity in your home. This product not only pays off your original mortgage with new loan terms, it also gives you a lump sum based on your home equity, that is then rolled into the new loan amount.

When to Refinance Your Mortgage

Because refinancing comes with both pros and cons that vary by situation, here are a few instances where it can be most helpful. If any of these situations apply to you, you should at least look into refinancing more closely to see if you could benefit.

When Interest Rates Drop

Up until recently, interest rates have been slowly but steadily rising from the all-time low experienced in the aftermath of the Great Recession. But the Federal Reserve recently reversed course and has placed a hiatus on rate hikes for the rest of the year – at a minimum.

Some analysts even predict another rate cut in either 2019 or 2020. That part is conjecture, but if you recently purchased a home after a rate increase, you may find that rates have mellowed out, which could equate to substantial savings.

When Your Credit Score Jumps

Perhaps you’ve been steadily working to improve your credit score, or paid off a large credit card balance and noticed a major boost. If you qualified your mortgage with less-than-excellent credit and have now jumped into a different credit category, you could qualify for a much better rate.

When You Can’t Afford Your Monthly Payments

Maybe you could afford your home when you first moved in, but your circumstances have changed. Whether you lost your job, had a serious illness, or went through a divorce, life changes and so do our financial abilities.

In some cases, you may want to consider refinancing to extend the length of your mortgage and lower your payments in order to stay in your house. This can have major long-term implications for your finances, especially if you’re older and refinancing to a 30-year mortgage. But it’s still an option if you feel backed into a corner.

You Qualify to Drop PMI

Private Mortgage Insurance (PMI) is a hefty fee that’s included in your monthly payments when you don’t make a full 20% down payment. Once you have 20% equity in your home, you may be able to drop off that charge with a refinance. Because home values are rising across the country, it’s taking less time for homeowners to reach that equity threshold.

With a conventional loan, you may be able to get your PMI dropped without refinancing – simply ask your lender. If you have an FHA loan, however, you’ll likely need to completely refinance the loan in order to get rid of your PMI.

What You Need in Order to Refinance

Refinancing is almost as complicated as getting a new mortgage, but at least you won’t have to deal with sellers throughout the process. Here’s some basic documentation you’ll likely need as part of the application process:

• Recent paystubs and bank statements
• Tax returns from the last two years
• Credit report (requested by the lender)
• Statements of debts and assets

The refinancing process also requires a home appraisal to confirm the value of your property. Most lenders require that you pay this fee upfront, although some may include it in the closing costs.

Frequently Asked Questions

by Lauren Ward

Personal Finance Writer

Lauren Ward is a personal finance writer with nearly ten years of experience covering topics like loans, credit, and real estate. She lives in Virginia with her husband and three children.