What is refinancing? It’s a term that you hear frequently, but many don’t know what, exactly, it means. Refinancing your mortgage simply means replacing your old mortgage loan with a new one. It sounds like a complicated process, but if you prepare, do your research, and are patient in seeking the best option, it can be tremendously beneficial.
There is an array of reasons you might consider refinancing a mortgage. They include:
- Lowering your interest rate
- Reducing your monthly payment
- Accessing your equity
- Paying off your loan faster
There are several different changes you can pursue while refinancing a mortgage as well. Those include, but are not limited to:
- Changing from an Adjusted-Rate Mortgage to a Fixed-Rate Mortgage
- Changing the term of your mortgage
- Using improved credit to find a better deal
And much more. Follow along, and we’ll give you a little background, then break down both the why and the how of refinancing a mortgage.
What is Refinancing a Mortgage?
When you purchase your home, unless you have enough to pay in cash upfront, you secure it by taking out a mortgage to pay for it. Refinancing a mortgage means replacing your initial mortgage with a new one. Rather than paying the seller of the home, the new mortgage pays off the balance of the original loan.
Your first mortgage might have had suboptimal terms, but you took it out just to get yourself in the door of your new home. If your budget has changed, or your credit score has improved, it might be the perfect time to explore refinancing.
Why Do You Refinance Your Mortgage?
Typically, the primary reason many people refinance their mortgage is to lower their monthly payments. If you’re able to secure a lower interest rate (thanks to a larger income or improved credit score), that could kill two birds with one stone—you would reduce the amount you owe monthly, while also saving on total money long term.
It’s also possible to stretch the term of the mortgage. If you initially took out a 15-year mortgage, you could switch to a 30-year mortgage. That would add up to a larger total in the long run because there is more time for interest to accumulate. But it could mean big savings in the short term.
Another reason you might pursue a mortgage refinance would be to tap into the equity of your home. As you pay off your mortgage, you build up equity—essentially, the value of your home that is yours. If your home is valued at $200,000, for example, and you’ve paid off $100,000, you’d have $100,000 in equity.
A cash-out refinance is a mortgage where you are loaned more than you owe, essentially cashing out your equity to use for other purposes (typically paying down other debts that might have higher interest rates). Most cash outs allow you to borrow on no more than 80% of your equity. Other common reasons for refinancing a mortgage include switching to a shorter term so you can pay off your home sooner, or eliminating private mortgage insurance.
How to Refinance a Mortgage
When you refinance your mortgage, there are a few things to keep in mind. First of all, you should go through the process with a specific goal in mind. Review your current mortgage, and determine your priorities of what you would most like to change. Also, refinancing isn’t free. You’ll have to pay refinancing fees, and these vary from lender to lender. So be aware, and look for the best deal.
Shop around. Rather than applying for a single new mortgage, you should apply for a loan with somewhere between three and five lenders so that you can compare and contrast and pursue the best option for yourself. However, if you stagger your applications too much, that can hurt your credit score—be sure to apply within no more than a two week period to mitigate this effect.
Once you review each loan estimate document and determine which option is best for you and your priorities, go ahead and lock your interest rate. That will give you a period to close on your loan without worrying about the rate changing. Then, simply work with your lender to close. Once you’ve done so, your new terms will start right away.
The Bottom Line
Refinancing your mortgage can be a great way to improve your financial standing both short and long term. Eager to get into their home, many homeowners land first mortgages that are less than favorable. Refinancing can be a great way to reduce your monthly payment, save long term money on interest, or even pay off your loan sooner to own your home outright!
The process is the same as securing your first mortgage. You’ll apply with lenders, compare offers, and work to close on your loan. And if you do it right, you can pull in some major savings.