How Does Mortgage Refinancing Work?

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When you refinance your mortgage, your lender will pay off your previous home loan completely so that you are only left with the refinanced mortgage. The application process and submission requirements are generally the same as with a standard mortgage. You will need to have your home appraised, submit financial documents, and pay closing costs to complete the process. There are many reasons why people choose to refinance, but one of the main objectives is to save money. If you’re having trouble making your monthly payments, knowing how to refinance a mortgage can be a smart and effective way to get yourself some relief. By comparing lender prices for lower rates, you may be able to reduce your monthly payment by a significant amount.

Why do You Want to Refinance Your Mortgage?

When considering a refinance, there are a few steps you should take before meeting with a lender. First define the purpose of the refinance. Are you looking to make money off the equity or change from a fixed-rate to a variable rate? Once you figure out the motivations for your refinance, you’ll be better prepared moving forward.

What Should You do Before Applying for a Refinance?

First thing, get your papers in order. Look at your credit score to see what type of shape you’re in and also research the value of your home and others in your neighborhood in order to get an idea of your possible equity. Print out your bank statements, pay stubs, and all other relevant financial documents that lenders may ask for. You should also take some time to look at online mortgage calculators, where you can plug in data about your fees, loan amount, and interest rates in order to determine your monthly payment and whether or not refinancing will pay off for you. Use this knowledge when meeting with lenders in order to know who’s giving you the better deal. Make sure to study the loan estimate given by each lender in order to determine which one is the right fit.

How Will Refinancing Affect My Interest Rate?

The new loan term that you choose for refinancing can have an impact on your interest rate. For example, if you choose to refinance for a 15-year fixed-rate mortgage, you will likely have a much lower interest rate than you would with a 30-year fixed rate mortgage. During the refinancing process, your monthly rates will be set lower, but the length of the loan will often reset according to the new term that you select. For example, if you owned a home for 10 years and had a 30-year fixed-rate mortgage, your refinanced mortgage would not be set to 20 years; it would reset back to 30 again. This is why it’s important to select a term that fits your needs, your budget, and the length of time for which you want to pay off the home. Why Shouldn't I Refinance my Mortgage?

The Fees and Closing Costs

Refinanced mortgage comes with a number of fees and closing costs which can easily run into the thousands of dollars. Depending on how high these fees are, it may take a while before the savings of the refinance offset the fees. This is known as the “break-even point,” where your savings will begin overtaking the expenses of refinancing. Each month after the 20 months represents your true savings.

Pre-payment Penalties

Many mortgages come with prepayment penalties in place to allow the lender to recoup some of the lost interest payments in the event you decide to pay off the loan early. Depending on how high these are, it may offset your savings to the extent that refinancing isn’t worth it. Crunch the numbers, then decide if it’s worth it.

You’re Near the End of Your Mortgage Term

If you’re on the verge of paying off your mortgage it might make more sense to just continue making the payments. Even if these payments are higher than what you’d get with a refinance, once the costs and fees are plugged in, it might not be worth it. Not only that, but you’ll also be extending the term of the mortgage just as you’re nearing the finish line. What is Cash-Out Refinancing? Another reason to refinance is to take out a large loan on your existing equity and the payments you have already made, which is larger than the fees and the remaining loan. This type of refinancing is known as cash-out refinancing. It includes a payback of money that you have already paid toward the home, and it’s ideal for when you’re making major life changes or navigating tough times.

How does cash-out refinancing work?

It’s pretty straight-forward. Let’s say your house originally cost $200,000. If you already paid off $50,000, your principal balance would now be at $150,000. By taking out a $175,000 refinancing agreement on the loan, you can get an extra $25,000 that you pay back as part of your monthly mortgage payments. This is a better option than taking out a separate loan for the $25,000 and the money can be used to help you get through a dry patch or pay off a separate, higher interest loan, such as credit card debt. If your home is appraised for more money than you originally bought it for, cash-out refinancing gives you the option of collecting even more money. For example, your home may be valued at $250,000 instead of $200,000. If you’ve already paid $100,000 off of the home, the remaining principal balance would be $100,000. The increased value and equity in the home after appraisal would qualify you for a cash-out refinancing of $150,000. Your mortgage terms would be based off of this amount, and you could receive $50,000 in cash after the agreement closes. 

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