How to Refinance Your Mortgage

Refinancing your mortgage carries a lot of the same challenges you faced in looking for your first mortgage. You'll need to sort through much of the same paperwork and compare estimates from different lenders. However, because refinancing means changing over from one mortgage to another, it's also important to know how to weigh your current situation against your options for refinancing.

Determine What to Change in Your Mortgage

Refinancing is an opportunity to change the balance, interest rate or term length of your mortgage to better suit your financial needs. These three factors define how much you borrow, the price you pay to do so, and how quickly you must repay the balance. Defining what you want out of a refinance helps you focus your search for the right mortgage lender.

Refinancing Lets You…Example
Interest RateSecure a lower rateRates go down from 5% to 4%
Loan TermShorten your repayment scheduleSwitch from a 30-year to a 15-year mortgage
Outstanding BalanceIncrease your balance to withdraw cashObtain a cash-out refinance

Most homeowners see refinancing as a way to secure a lower interest rate, which leads to smaller monthly mortgage payments and decreases the final amount paid in interest. However, refinancing also allows you to adjust your outstanding balance and the term of your loan. Some borrowers actually choose to increase their debt in the form of a cash-out refinance, which lets them increase their mortgage balance in exchange for an immediate cash withdrawal of the difference. This is an increasingly popular way to tap the equity on a house for other purposes.

Refinancing can also be a means to change the type of mortgage you're in. For instance, a homeowner with an adjustable rate mortgage might want a new fixed rate mortgage to avoid rising rates. Others may seek refinancing to eliminate mortgage insurance costs that are incorporated into the interest rate on their old mortgages. If you have an FHA mortgage, refinancing to a conventional loan can help you avoid rules that otherwise prevent you from removing insurance premiums.

Prepare Paperwork and Financials

Once you determine the type of mortgage you'll refinance into, you can begin gathering the documents required for approval from mortgage lenders. The process for a cash-out refinance will work somewhat differently from a standard rate-and-term refinance, but the requirements are similar. You'll need to provide lenders with a good deal of information about your income, assets and debts.

Pay stubs and tax returns. Proof of income gives lenders some idea of how a refinance would fit into your ability to make consistent payments. This is usually represented in W-2s and pay stubs that cover at least the past few months prior to your application.

Bank deposits, investments and proof of other assets. A comprehensive summary of your available funds is relevant to the closing costs you'll need to pay when signing the new mortgage. This includes money in savings and checking accounts as well as investments.

Statements for outstanding debts. Credit cards, student loans, car leases and your existing mortgage are just a few examples of what you'll need to report when you refinance. Any loan you're currently repaying will need to be documented and included in your applications.

Mortgage lenders will also run queries to determine how good your credit score is and schedule an appraisal for the current value of your home. These round out your financial profile and help determine whether a refinance is worth the risk for a lender to approve.

Compare Estimates From Lenders

Once you've determined what you want out of a refinance and assembled both your documents and enough upfront funds, you can start shopping for quotes from individual mortgage lenders. Both traditional banks and direct lenders offer refinancing services, and many lenders from both categories will publish general "ballpark" rates online. However, these rates tend to work on generous assumptions for the underlying borrower profile, with excellent credit scores and high down payments. It's important to compare your loan offers to pick the best mortgage refinance rate.

The most accurate way to gauge your choices is by requesting a formal estimate from each lender you consider. Mortgage lenders are legally required to provide a detailed estimate no later than 3 days after borrowers provide their basic information. These estimates must include the interest rate, a projected monthly payment and closing costs. Lenders will also inform you about which services you're allowed to shop for on your own, such as property appraisal.

Choose a Payment Option For Refinancing

After you've picked a lender, there is one other consideration: closing costs. Since refinancing basically replaces one mortgage with another, the original balance is often paid for in full by the refinancing lender and carried over into the new mortgage. This means you won't need as much money upfront for a refinance as you probably did for your original mortgage. However, refinancing still involves closing costs that can add thousands of dollars to your initial expenses. You can cover those fees in multiple ways:

  • a straight cash payment
  • higher interest rate on the new mortgage
  • increased balance on the new mortgage

While your options may differ according to your specific mortgage lender, paying these fees in a lump sum is generally more cost-effective than folding them into your refinance mortgage. Increasing the balance or the interest rate will chip away at the gains you're hoping to make in terms of lowering the cost of your loan. If you're short on cash, you should take the time to calculate how a higher rate or balance will impact the cost-effectiveness of a refinance.

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