How to Refinance Your Mortgage
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.
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 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.
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.
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 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.
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?