How to Refinance Your Mortgage

by Michael Kling on 7 March 2013 10 comments
Photo: Victor1558

When you refinance a loan you replace it with a new loan that, hopefully, has better terms and a lower interest rate. Savings could be substantial, depending on the size of the loan and the interest rate change. Although interest rates change constantly, they are now near historic lows, which has prompted many borrowers to refinance.

Online calculators, such as one available on Bankrate.com, can help you calculate how much you can save with a new loan. For a rough guideline, every percentage point reduced equals $1,000 saved for every $100,000 borrowed per year. For example, refinancing a $100,000 loan from a 6% to 4% interest rate would save you $2,000 a year.

All things being equal, the shorter the loan term, the lower the interest rate. Shorter terms also help you pay off the debt faster. That's why many homeowners refinance their 30-year home loans into 20-year, 15-year, or even 10-year mortgages. (See also: 6 Great Reasons for Paying Off the Mortgage on Your Home)

The disadvantage is that shorter terms create higher monthly payments because the payments are squeezed into a shorter timeframe.

All right. Let's take a look the variety of refinancing plans available.

Different Types of Refinancing

While many borrowers want the lowest interest rate and hope to pay off debt as quickly as possible, the best loan terms for a particular homeowner depends on their particular situation.

Term

Some borrowers refinance into a longer term, such as a 40-year term, to get the lowest monthly payment possible. Others get a cash-out refinance, or get a new loan that's larger than the current one, to pay for large expenses like a home renovation or new car.

Fees

Fees are probably the biggest downside to refinancing. Mortgages often require the payment of "points" at closing — one point equals 1% of the loan amount. Some points are simply a lender's fee, while bona fide "discount points" lower your interest rate. When seeking a lender, ask if points lower the interest rate.

Other costs to expect include an application fee, loan underwriting fee, an appraisal, title policy, a recording fee, and fee for an attorney or closing agent.

Some lenders offer "no cost closings" or let borrowers wrap their loan costs into the total loan amount — a solution if you don't have enough cash on hand but not the best option if you're trying to pay off the loan sooner.

Lenders

Commercial banks, which hold savings and checking accounts, typically offer refinance loans. Other options include the company holding your current home loan, mortgage banks, firms specializing in making mortgage loans, and mortgage brokers, who accept applications and arrange loans between borrowers and lenders, and credit unions. Credit unions typically serve limited audiences, such as a company's employees and large civic groups, but some credit unions accept anyone who lives, works or worships in their community.

You can also use online tools such as Bankrate to search for lenders.

Refinancing Tips

Follow these simple tips to get the best possible loan.

Understand Your Current Loan

Find out what type of mortgage you have. If your loan is insured by the Federal Housing Administration or is owned or guaranteed by Fannie Mae or Freddie Mac, you might qualify even if your mortgage balance is larger than your home's value and you have little or no home equity.

Review Your Credit History

Check your credit at myfico.com for mistakes, which are common, before applying for a loan. Don’t apply for new credit card or another loan, don’t max out a credit card, and don’t make more credit inquiries, all of which can hurt your credit.

Shop Around

Shop around for the best rate and lowest fees. Shopping, comparing, and negotiating can save you thousands of dollars over the life of the loan. Beware of companies quoting rates significantly lower than competitors. It could be a bait and switch tactic or entail high closing costs. A lender can quote you any rate over the phone but is not committed to it until you lock-in the rate, which typically entails a fee.

Take Good Notes

Get everything in writing, including the rate lock information, loan program, mortgage rate, closing costs, and points you’ll pay, if any.

Get Organized

Organize your financial paperwork. Collect your bank statements, tax returns, pay stubs, W-2s, and other income documentation.

Scrutinize Closing Costs

Examine the Good Faith Estimate of costs, which lenders must provide by law. Some fees might be negotiable — so negotiate! Since you already have a title policy, you should get a discount on a policy renewal. Compare the GFE against the final HUD-1 paperwork, which lenders also must provide, for big cost discrepancies.

Review the Paperwork

Ask to see loan paperwork before the day of the closing, so you have time to read the documents.

Have Enough Closing Funds

In addition to paying lender fees, you might need money to set up new insurance and tax escrows. The mortgage refinance closing can be delayed if you don’t have enough funds on hand.

Have you taken advantage of historically low interest rates to refinance? How did the process go for you?

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Guest's picture
Michael

We refinanced in late 2011 with Citi, who had originated our original mortgage. The whole process took less than 60 days. Our interest rate was cut nearly in half. We added $150 to our monthly payment, but the amount toward principle increased by $500 from our previous mortgage, and we cut our total term by 10 years. I couldn't ask for much better than all that.

Guest's picture
Carla

Search for local savings & loan-style banks, or local credit unions to avoid title insurance. Depending on the value of your house, that could save you thousands in fees. However, many fees are protected by federal law, and cannot change. There is a section on your HUD-1 marked "fees that cannot change." If those fees have increased substantially, you should demand that they be decreased in accordance with federal law.

Also, shop some mortgage brokers along with banks. Frequently, brokers will have "specials" that allow them to offer better pricing than the bank's loan officers. For example, my brokerage just got off a special with one bank that allowed us to offer loans .125% under retail, and just got on another than allows us to offer loans with a 1.5 point credit (as in, free money for the borrower compared to a retail price) at any interest rate. Check with the NMLS and local regulators to make sure you choose a reputable broker. NAMB (The National Association of Mortgage Professionals) also offers a database of ethical brokers.

Guest's picture
Alan

Hi,
I have refinanced my current mortgage a few times which lowered the payment from $3,500 to $2,800. We used a 5 year ARM. We still have about 3 years left but are in a situation where we owe more than the house is worth, like $60-80k more. We do not see the value increasing that much in the near future and have been attempting to get a fixed rate at .25% less than our ARM. Unfortunately every company I called said there are new laws out there that state that if we do not save 5% on our payment or are not at the end of the ARM, then we could not refinance at this time. Apparently these are some new laws that have changed in the past 6 months or so. I have not called them back but would love to see if anyone else ran into the same problem recently.

Guest's picture
Carla

Hi Alan,

This is a very strange situation. It's not very common that a person would be prevented from refinancing for any legal reason, outside of some very specific programs. What state are you in, and who holds your current mortgage? Was it done through a federal program like FHA, HARP, VA, etc? Are you in or just out of bankrupt, or have any legal restrictions on your finances? (P.S. I'm not a licensed loan officer, just experienced. I cannot legally offer you anything except resources and ideas.)

Guest's picture
Alan

Hi Carla,

To be honest, I cannot remember since we refinanced but some people I spoke to believe that I have an FHA. I would need to look at the settlement paperwork. We currently live in MD. Both of our credit scores are 730 and we never been in bankruptcy. I think between us we have had 1 late payment but was several years ago when our new card company never sent us the first bill. Sadly they blamed us for it.

Guest's picture
Carla

Hi Alan,

Despite your good credit, I'm guessing that there are some complicating factors within your mortgage. Call the bank that owns the loan (or your servicer-who you pay monthly) and ask for a copy of the note, mortgage, HUD-1 statement, and your last appraisal if you don't have any of those. Go to www.namb.org and find a local mortgage broker. Brokers are frequently more creative and flexible than banks, and may have a solution for your problem. Don't be afraid of a broker because of things you heard during the "bad times" before the crash. Brokers and their fees are now heavily regulated, especially in Maryland, and you'll receive several forms making the terms of your loan clear. Check the NMLS website for any regulatory history, just to be sure. Good luck!

Guest's picture

Thank you for the advice Carla. Our mortgage just got bought out by Chase last month and I just saw that we still have 3 years on the current 5-1 ARM at 3.5%. I may hold off on switching for a bit now that I see we have more time than I originally thought. I do not see rates really jumping up any time soon but you never know. Hopefully it will work out.

Guest's picture

It is going to be interesting this coming spring and summer with the housing market starts to heat up again. Lenders will be competing for a smaller number of buyers and may start to lower interest rates. Low interest rates are a good thing if you are in the market to refinance your mortgage. You can take advantage of the saves. Even a 0.5% change rates will save people thousands of dollars. If you manage your debt well and have a good credit history, I would shop around and seriously consider the savings vs costs of refinancing.

Guest's picture
Carla

Pat,

Mortgage rates aren't tied to supply and demand at all. Banks can quibble with rates in the same way that gas stations can lower their prices $.10 cents just to mess with other stations, but they can't actually lower market rates any more than gas stations can lower gas prices. Mortgage rates are tied to treasury bonds, which are tied to Fed policies and other, much larger, market forces. The demand for refinances has been astronomical for the last two years. If demand forced rates lower, we'd be seeing 1% rates on mortgages by now. Refi demand is falling off sharply, and purchase demand increase slowing. If anything, the slowly rising rates we're seeing now are going to stifle the purchase market, especially when the Fed quits "easing" the market and lets things return to normal.

Guest's picture

Refinancing can be a great idea for those looking to get a better rate, but careful calculation – as you mentioned – needs to take place first. In our case, unfortunately we have an ARM loan, but will be moving within a couple of years (we're either going to rent or get a fixed rate).

Great thoughts here, thanks!