How does refinancing work? The process of refinancing a mortgage involves replacing your current mortgage with a new one – often with more favorable terms. Going through the refinancing process might lower the interest rate on your loan, reduce your monthly payment, or provide access to home equity, among other benefits.
What is a mortgage refinance?
The mortgage refinancing process is when you replace your current home loan with a new mortgage. Homeowners enter the refi process for various reasons, including taking advantage of lower interest rates, shortening the loan term, eliminating private mortgage insurance (PMI), changing loan types, and borrowing against home equity.
How does refinancing work?
During the process of refinancing a mortgage, you take out a brand new home loan which will pay off the remaining balance on your current mortgage. You’ll go through an approval and underwriting process similar to when you took out your current home loan.
After going through all of the refinancing process steps, you’ll have a completely different home loan with new terms, including interest rate, monthly payment, and other details. In many cases, you may also have a new loan servicer.
How to refinance a mortgage step by step
The refinancing mortgage process may appear to be complicated, but it’s relatively straightforward. Here, we’ll walk you through the six steps in refinancing a mortgage.
Step 1: Build your credit score
In the refinancing process, lenders will review your credit history and credit scores. Even if interest rates have dropped since you took out your home loan, your credit score will play a significant role in the interest rate you will get and, ultimately, the total cost of the loan.
To ensure you get the best interest rate, check your credit history before applying, which you can do for free at AnnualCreditReport.com. After reviewing your reports, take steps to improve your credit score, such as making all your payments on time and keeping your utilization ratio low. Additionally, avoid taking out any new loans in the months leading up to the refi process.
Step 2: Shop lenders and compare refinance mortgages
To get the most competitive interest rate and loan terms during the refinancing mortgage process, shop around and compare loan terms among multiple lenders. You do not have to refinance your home with your existing lender, and in many cases, a new lender may have a better interest rate and more favorable loan terms.
When comparing refinance loans, in addition to reviewing the interest rate and monthly payments, also look at the annual percentage rate (APR), total interest paid, loan term, and closing costs. These factors contribute to the overall cost of the loan and will determine whether refinancing makes sense for you. Consider using a mortgage refinance calculator to compare multiple loans.
Step 3: Apply for the best offer and lock in the rate
After reviewing the terms of each loan, consider negotiating with lenders to get the terms and rate you’re looking for. Once you’ve identified the refinance loan you want to go with, you’ll officially apply for the loan.
The refinancing process varies among lenders; however, most give the option of locking in your interest rate. Locking in the rate prevents it from increasing if market rates rise before you close on the loan. Some lenders allow you to lock your rate for free, while others may charge a fee.
Step 4: Gather and submit your refi documents
Your lender will specify what documents you need to supply during the refinancing process but expect to provide much of the same information you gave when you first purchased your home. The type of loan you are applying for will also determine what you need to give to your lender. Most lenders will typically request the following during the refi process:
- Pay stubs for the last 30 days (and proof of other income)
- W-2 forms for the last two years
- Signed federal tax returns for the last two years
- Bank statements for the past two months
- Proof of assets and liabilities
- Details on the existing loan
- Social Security number
Step 5: Complete the underwriting and appraisal process
Next in the refinancing steps is underwriting. Here are a few things that will happen during this stage:
- Income verification. Your lender will verify all the financial information you provided to see if you qualify for a home refinance. If necessary, your lender will request additional information.
- Home appraisal. Your lender may order an appraisal of the property to determine its value and your loan-to-value (LTV) ratio. In some cases, your lender may waive an appraisal.
- Title insurance. Your lender will require a title search and title insurance on the new loan. You may be able to reduce your title insurance costs by going with the same company you used on the initial loan.\
Do you have to have an appraisal during the refinancing process?
Depending on the type of loan you’re applying for, your lender may not require an appraisal on your home during the house refinancing process. For example, homeowners with an existing loan backed by the Federal Housing Administration (FHA) or the U.S. Department of Veterans Affairs (VA) may be able to refinance without a home appraisal if they choose an FHA streamline refinance or VA interest rate reduction refinance loan (IRRRL), respectively.
For other loan types, your lender may offer an appraisal waiver and instead use an alternative method to value the home. This can often save time and money instead of doing a full appraisal. Keep in mind that the home’s value will determine whether you qualify for a refinance and will play a role in how much you can borrow against your equity if you plan to do a cash-out refinance.
For example, conventional mortgages (non-government loans) allow a maximum LTV ratio of 80% for a cash-out refinance. If, for instance, you owe $300,000 on your mortgage, and you wanted to borrow an additional $50,000 against your equity, that means your home would need to appraise for at least $437,500. To figure out your LTV ratio, divide the balance of your mortgage by the home’s value.
Step 6: Close on your loan
After you’ve gone through the above refinance process steps, you’re ready to close on the new loan. The refinance process timeline will vary depending on the loan type and your lender’s process. In any case, your mortgage company or bank will work with you to schedule the date and location of the closing.
At least three business days before the closing date, your lender will provide you with a closing disclosure. This document provides the final details of your mortgage, including the loan terms, projected payments, and closing costs.
Expect to bring the following to your closing:
- Closing disclosure (to compare to the final documents)
- Cashier’s check or proof of wire transfer for closing costs and down payment
- Checkbook (in case there are last-minute changes)
Keep in mind that you legally have three business days after closing to cancel the refinance loan, known as the right of rescission. Review all the loan details on the final loan documents to make sure you understand and agree to the mortgage terms.
Pros and cons of the refinancing process
Before jumping into the refinancing process, consider the following advantages and disadvantages.
Pros and cons of the refinancing process
|Can potentially lower your interest rate||Can increase the total cost of the loan|
|Can lower your monthly payment||Can lengthen the time it takes to pay off the loan|
|Can reduce the total cost of the loan||Can increase how much you owe on your home|
|Can shorten the loan term||Closing costs can be high|
|Can eliminate PMI and other loan fees||May result in paying more interest|
|Can make your loan more stable||Can add PMI payments (if the new LTV ratio is more than 80%)|
When should you refinance your home?
The process of refinancing a mortgage should typically result in a tangible net benefit that improves your overall financial picture. For many homeowners, the refinancing mortgage process makes sense when interest rates fall below the original rate on their loan, but it’s not the only reason to refi.
Here’s a brief overview of why you might consider the house refinancing process:
Reducing your interest rate: If your original mortgage interest rate is higher than current rates, it may make sense to refinance into a new loan so you snag a lower rate. This can shave thousands of dollars in interest payments over the life of your loan.
Reducing your monthly payment: Getting a lower rate may also reduce your monthly mortgage payment, which can help keep your housing costs more predictable for the long term.
Shortening your loan term: Refinancing from a longer-term loan, such as 30 years, into a 15-year loan, for example, can cut your lifetime interest payments down considerably and pay off the principal balance much faster. However, if you opt for a shorter-term loan, your payment may go up, so make sure your budget can handle the higher payments and you’re meeting other financial goals, like saving for retirement and debt obligations, first.
Swapping an adjustable-rate loan for a fixed-rate mortgage: Adjustable-rate mortgages can be a smart financial move when you first buy a home and you plan to sell before the loan resets. However, if plans change and you decide to stay in your home for the long haul, ARM payments can become unaffordable once the loan resets and the rate becomes variable after an initial fixed period of a few years. The refinancing mortgage process can replace an ARM with a more stable fixed-rate loan.
Cashing out on home equity: The process of refinancing a mortgage isn’t always about getting a lower rate or switching loan types. Many homeowners use cash-out refinancing to tap their home’s equity to use for home improvements, consolidate high-interest debts, or other financial goals. A cash-out refinance replaces your existing loan with a new, larger loan, and allows you to withdraw the difference between the two amounts in cash. The amount you can tap in a cash-out refi depends on how much equity you have and the new loan type.
Eliminating PMI or MIP: If you put less than a 20% down payment when you took out your original loan, your lender likely added PMI to your conventional loan. For FHA loans, mortgage insurance premiums (MIP) are paid upfront and annually. Annual MIP drops off from FHA loans after 11 years if a borrower puts down at least 10%. Putting down less than 10% on an FHA loan means you’ll pay annual mortgage insurance premiums for the life of the mortgage.
It’s no wonder that mortgage insurance premiums can add up over time. Refinancing once you’ve gained enough equity can remove PMI. FHA borrowers who put down less than 10% would need to refinance into a conventional mortgage to eliminate MIP once they have enough equity and can qualify for a non-government loan.
Calculating the break-even point
Before you get too deep into the refinance process, you’ll want to figure out if the refi process makes financial sense by calculating how long it takes to recoup your closing costs in relation to your monthly savings. This is known as the break-even point.
For example, let’s say you refinance a $300,000 mortgage with refinance closing costs totaling $6,000 and a monthly savings of $274. To calculate when you’ll break even, you’d divide the closing costs by the monthly savings ($6,000 / $274), which is 22 months. To make the mortgage refinance process worth the expense, you’d need to stay in your home for 22 months to realize your savings to avoid losing money.
Mortgage refinance FAQs
How long does it take to refinance a house?
This varies by lender, but expect a typical refinance to take about 30 to 45 days. Government-backed FHA and VA loans can take longer due to extra requirements.
How much does a mortgage refinance cost?
Closing costs for a mortgage refinance can range from 3% to 6% of the loan amount. You can offset these up-front fees by opting for a no-closing-cost refinance. A no-closing cost refinance isn’t free, though; you have the option of either rolling the closing fees into your loan amount or taking a higher interest rate in exchange for your lender paying the closing fees upfront.
Should you refinance into another 30-year home loan?
While this option may result in a lower payment, you’re restarting the clock on your home loan. As a result, you’ll pay more interest in the first half of your amortization schedule. Your lender may offer the option of a shorter-term loan or a loan term similar to what you currently have. So, if you’re already five years into a 30-year mortgage, your refinance lender might allow you to choose a 25-year loan term so you’re not starting over at 30 years.
If you’re thinking about refinancing your home loan, a Finance of America Mortgage Advisor can help you compare your best options.