Refinancing A Mortgage: How It Works
Hanna Kielar4-minute read
December 08, 2020
Your home is an investment. Refinancing is one way you can use your home to leverage that investment. There are several reasons you may want to refinance, including getting cash from your home, lowering your payment and shortening your loan term.
Let’s look at how refinancing a mortgage works so you know what to expect.
What Is A Mortgage Refinance?
A mortgage refinance refers to the process of getting a new loan for your home. When you refinance, the new mortgage loan pays off the old one, so you’re left with just one loan and one monthly payment.
There are a few reasons people refinance their homes. You can use a refinance to cash in on your home’s equity or get a better interest rate.
A refinance could also be used to remove another person from the mortgage, which often happens in the case of divorce.
How Does Refinancing Work?
The refinancing process is often less complicated than the home buying process, although it includes many of the same steps. Here’s how the refinancing process works.
When you apply to refinance, your lender asks for the same information you gave them when you bought the home. They’ll look at your income, assets, debt and credit score to determine whether you can pay back the loan.
Some of the documents your lender might need include your:
- Two most recent pay stubs
- Two most recent W-2s
- Two most recent bank statements
Your lender will also need your spouse’s documents if you’re married. You might be asked for more income documentation if you’re self-employed.
You don’t have to refinance with your current lender. If you choose a different lender, that new lender pays off your current loan, ending your relationship with your old lender. Don’t be afraid to shop around and compare each lender’s current rates, availability and client satisfaction scores.
Locking In Your Interest Rate
After you get approved, you may be given the option to lock your interest rate so it doesn’t change before the loan closes.
Rate locks last anywhere from 15 – 60 days. The rate lock period depends on a few factors like your location, loan type and lender. If your loan doesn’t close before the lock period ends, you may be required to extend the rate lock, which may cost money.
You might also be given the option to float your rate, which means not locking it before proceeding with the loan. This may allow you to get a lower rate, but it also puts you at risk for getting a higher one. If you’re happy with rates at the time you’re applying, then it’s generally a good idea to go ahead and lock your rate.
Once you submit your application, your lender begins the underwriting process. During underwriting, your mortgage lender verifies your financial information and makes sure that everything you’ve submitted is accurate.
Your lender will verify the details of the property, like when you bought your home. This includes an appraisal to determine the home’s value. The appraisal is a crucial part of the refinance process because it determines what options are available to you.
If you’re refinancing to take cash out, for example, then the value of your home determines how much cash you can get. If you’re trying to lower your mortgage payment, then the value could impact whether you have enough home equity to get rid of private mortgage insurance or be eligible for a certain loan option.
Just like when you bought your home, you must get an appraisal before you refinance. Your lender orders the appraisal, the appraiser visits your property and you receive an estimate of your home’s value.
To prepare for the appraisal, you’ll want to make sure your home looks its best. Tidy up and complete any minor repairs to leave a good impression with the appraiser. It’s also a good idea to put together a list of upgrades you’ve made to the home since you’ve owned it.
If the home’s value is equal to or higher than the loan amount you want to refinance, it means that the underwriting is complete. Your lender will contact you with details of your closing.
What happens if your estimate comes back low? You can choose to decrease the amount of money you want to get through the refinance or you can cancel your application.
Closing On Your New Loan
Once underwriting and home appraisal are complete, it’s time to close your loan. A few days before closing, your lender will send you a document called a Closing Disclosure. That’s where you’ll see all the final numbers for your loan.
The closing for a refinance is faster than the closing for a home purchase. The closing is attended by the people on the loan and title, and a representative from the lender or title company.
At closing, you’ll go over the details of the loan and sign your loan documents. This is when you’ll pay any closing costs that aren’t rolled into your loan. If your lender owes you money (i.e., if you’re doing a cash-out refinance), you’ll receive the funds after closing.
4 Reasons To Refinance Your Mortgage
As we mentioned, there are a variety of reasons why you might want to refinance your mortgage. Let’s look at some of the main reasons here.
1. Change Your Loan Term
Many people refinance to shorten their loan term to save on interest. For example, say you started with a 30-year loan but can now afford a higher mortgage payment. You might refinance to a 15-year term to get a better interest rate and pay less interest overall.
You can also lengthen your loan term to lower your monthly payment.
2. Lower Your Interest Rate
Interest rates are always changing. If rates are better now than when you got your loan, refinancing might make sense for you. Lowering your interest rate can lower your monthly payment and you’ll pay less interest over the life of your loan.
3. Change Your Loan Type
There are many reasons a different type of loan may benefit you. Perhaps you originally got an adjustable rate mortgage to save on interest, but you’d like to switch to a fixed-rate mortgage while rates are low.
Maybe you finally have enough home equity to refinance your FHA loan to a conventional without paying for private mortgage insurance.
4. Cash Out Your Equity
With a cash-out refinance, you borrow more than you owe on your home and pocket the difference as cash. If your home’s value has increased, you may have enough equity to take cash out for home improvement, debt consolidation or other expenses. Using cash from your home allows you to borrow money at a much lower interest rate than other loan types.
What Does It Cost to Refinance?
The total cost of a refinance depends on a number of factors like your lender and your home’s value. Expect to pay 2% – 3% of the total value of your loan.
The nice thing about refinancing is that you may not have to pay those costs out of pocket. In some cases, you can roll your closing costs into your loan so you don’t have to bring any money to the table.
When Should You Refinance Your Mortgage?
There are a lot of factors to consider when deciding if it’s a good time to refinance. Consider market trends (including current interest rates), as well as your personal financial health (especially your credit score). It’s a good idea to use a mortgage refinance calculator to calculate your break-even point after accounting for refinancing expenses.
When the time is right, refinancing is a great way to use your home as a financial tool. You can adjust your loan term, get a better interest rate and change your loan type to save money in the long-term. Or cash out your home's equity and use the money as you need it.
To see your refinance options and lock your rate, apply online now with Rocket Mortgage® by Quicken Loans®.
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