A mortgage refinance replaces your current home loan with a new one. Often people refinance to reduce the interest rate, cut monthly payments or tap into their home’s equity. Others refinance a home to pay off the loan faster, get rid of FHA mortgage insurance or switch from an adjustable-rate to a fixed-rate loan. Let’s consider some important initial aspects of refinancing a mortgage — and then run through the process step by step.
When you buy a home, you get a mortgage to pay for it. The money goes to the home seller. When refinancing a home, you get a new mortgage. Instead of going to the home’s seller, the new mortgage pays off the balance of the old home loan. Mortgage refinancing requires you to qualify for the loan, just as you had to meet the lender’s requirements for the original mortgage. You file an application, go through the underwriting process and go to closing, as you did when you bought the home.
Before you begin, consider why you want to refinance your home loan. Your goal will guide the mortgage refinancing process from the beginning. Reduce the monthly payment. When your goal is to pay less every month, you can refinance into a loan with a lower interest rate. Another way to reduce the monthly payment is to extend the loan term — say, from 15 years to 30. The drawback to extending the term is that you pay more interest in the long run. Tap into equity. When you refinance to borrow more than you owe on your current loan, the lender gives you a check for the difference. This is called a cash-out refinance. People often get a cash-out refinance and a lower interest rate at the same time. Pay off the loan faster. When you refinance from a 30-year mortgage into a 15-year loan, you pay off the loan in half the time. As a result, you pay less interest over the life of the loan. There are pros and cons to a 15-year mortgage. One downside is that the monthly payments usually go up. Get rid of FHA mortgage insurance. Private mortgage insurance on conventional home loans can be canceled, but the Federal Housing Administration mortgage insurance premium you pay on FHA loans cannot in many cases. The only way to get rid of FHA mortgage insurance premiums is to sell the home or refinance the loan when you have accumulated enough equity. Estimate your home value, then subtract your mortgage balance to calculate your home equity. Switch from an adjustable- to a fixed-rate loan. Interest rates on adjustable-rate mortgages can go up over time. Fixed-rate loans stay the same. Refinancing from an ARM to a fixed-rate loan provides financial stability when you prefer steady payments.
Reducing your monthly payment is usually the goal. And it’s tempting to refinance with another full 30-year term to lower your mortgage payment. But that means you’ll end up taking even longer to pay off your house and paying more interest over the long run. Instead, you can ask the lender to match your remaining loan term. For example, if you’ve had a 30-year loan for three years, you have 27 years remaining. You can tell the lender to set up the payments so you repay the refinanced loan over 27 years instead of 30. This way, you reduce the interest you pay over the life of the loan. This is mortgage amortization at work.