As a homeowner, you’ve almost certainly heard of a refinance. What you might not know is that there’s a lot more to a refinance than simply just getting a new mortgage rate. In this blog, we’ll break down the basics of refinancing your mortgage, how they work, the different types of refinance, and the type of refinance that might work best for you.
What is a Refinance and How Does One Work?
A home refinance replaces your current mortgage with a completely new home loan. When you refinance, your new lender typically uses your new, refinanced mortgage to pay off your existing mortgage. This way, you’re left with one monthly payment that has a new interest rate and principal (or the total balance owed on the loan).
If the following steps sound familiar, that’s because they are! The process for refinancing your home is a lot like your original mortgage process when you first bought your home — this time without the added stress of shopping for your home and competing offers on the home you’re itching to buy.
Application & Locking Your Rate
When you decide to refinance, you’ll need to apply with your income, credit score, and any current debts to ensure that you meet the eligibility requirements to refinance.
Once you’re approved, you’ll be quoted with a new interest rate. Just like when you bought your home, you can lock your rate for up to 60 days to ensure you still have access to your quoted rate if mortgage rates rise.
You can also have the option to float your rate; this means that you can potentially access a lower rate if they drop over time, but it also puts you at risk of getting a higher rate if they increase before you close.
Underwriting & Closing
Upon submission of your application and subsequent approval, your new loan will go through underwriting. During underwriting, your lender will cross-reference the financial documents and information you submitted for accuracy.
They’ll also require a refinance appraisal to determine the value of the property you’re refinancing. This appraisal is key to a cash-out refinance, which we’ll cover in more detail below.
Assuming you pass underwriting, it’s time to close your loan! Your lender or Loan Originator will send your Closing Disclosure (CD) which outlines all the final figures – including your new interest rate, closing costs, loan amount, and more. When it comes time to close, you’ll review the details of the loan, sign your loan documents, and pay any necessary closing costs. If you’re doing a cash-out refinance, this is when you’ll receive the money owed to you by the lender; but again, we’ll outline cash-out refinances in greater detail a little later.
Different Types of Refinance
So, now that you know how a refinance works, let’s cover the different types of refinances that are commonly used by homeowners. Below, we'll go more in-depth on rate & term refinances and cash-out refinances and expand on the ways that these two options work.
Rate & Term Refinance
The most popular type of refinance — and what you probably first think of when you think about a refinance — is a rate & term refinance. True to the name, this kind of refi simply updates the interest rate and the term (or the repayment length of your loan).
Homeowners choose to get a rate & term refi when they want to lower their monthly mortgage payment. This makes the most sense for you if interest rates are significantly lower now than they were when you initially bought your home.
Another option with a rate & term refinance is to shorten the term of your loan. This typically leads to a higher monthly payment but can significantly lower the total amount of interest paid on your loan.
Cash Out Refinance
If you’re looking to tap into the equity you’ve earned in your home to help pay for a home project or consolidate another debt, you might consider a cash-out refinance.
When you get a cash-out refinance, you essentially replace your existing mortgage with a new loan that’s larger than your current loan balance. The difference between your existing mortgage balance and your new mortgage is the amount of cash you receive.
Homeowners must understand that the larger loan amount means higher monthly payments and increased overall interest costs over the life of the loan. Therefore, careful consideration and thorough financial planning are essential before opting for a cash-out refinance to ensure it aligns with their long-term financial goals.
How to Know if a Refinance is Right for You
Now that you know the basics of refinances, how do you know if a refinance is right for you? Consider the points below. If one of these situations resonates with you, then a refinance might be on the cards for you!
Reduce Your Monthly Mortgage Payment
The most common reason homeowners refinance their homes is to reduce their monthly mortgage payments with a lower interest rate. Before you refinance to lower your monthly payments, consider your break-even point after considering closing costs. If you think you’ll only live in and/or own this property for another couple of years, it might cost more to refinance than it would to keep your existing mortgage.
Utilize Your Home Equity
Your home is an investment that gives back as much or more than what you put into it. If you want to complete a kitchen remodel, pay off existing debt, or generally get some funds for a one-time expense, you can use a cash-out refinance to tap into the equity you’ve been building since buying your home.
Change the Length of Your Loan
If you are comfortable paying a higher monthly mortgage payment to reduce the amount of interest you pay over the life of your loan, you can get a rate & term refinance to shorten the term of your loan. If you shorten your loan from a 30-year to a 15-year, you’ll pay more upfront but less over time since you’re accruing less interest.
Change Your Loan Type
If you have an adjustable-rate mortgage and want to switch to a fixed-rate mortgage to have a more stable monthly payment, a rate & term refinance is a great option for you. The same can apply if you have an FHA loan and want to switch to a conventional, a conventional loan and you want to utilize your VA benefits, or generally see another loan program that might work best for your situation. It’s a great idea to consult with your UMortgage Loan Originator to get an expert’s opinion when changing your loan type.
Eliminate Mortgage Insurance
If you financed your home with an FHA loan or your down payment was less than 20%, you were required to lump Private Mortgage Insurance (PMI) into your monthly mortgage payment. Often, mortgage insurance can account for up to $200 of your monthly payment — those dollars stack up over time! By refinancing to a conventional loan from an FHA loan or refinancing after having reached 20% equity in your home, you can refinance to eliminate your PMI payments from your mortgage.
There are plenty of great reasons to refinance your mortgage and a plethora of different types of refinances that can fit your unique financial situation. Your situation is unique, so if you’re still wondering what type of refinance might be best for you, reach out to your UMortgage Loan Originator for a personal consultation.
