Refinancing: What Is It And How Does It Work?

Your home is an investment. Refinancing is one way you can use your home to leverage that investment. There are several reasons 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.

Refinancing the mortgage on your house means you’re essentially trading in your current mortgage for a newer one – often with a new principal and a different interest rate. Your lender then uses the newer mortgage to pay off the old one, so you’re left with just one loan and one monthly payment.

There are a few pros and cons of refinancing. You can use a refinance to make use of your home’s equity, get a better interest rate and/or lower monthly payment. A refinance could also allow you to remove another person from or add them to the mortgage.

But the upfront costs required for refinancing may mean the lower monthly payment isn’t worth your while. That’s why it’s important to understand the refinancing process and make sure it’s the right move for you.

The refinancing process is often less complicated than the home buying process, although it includes many of the same steps. Let's walk through each step of the refinance process.

1. Choose A Refinance Type

The first step is to review the types of refinance to find the option that works best for you. Many types of refinancing options exist, but here are some common ones borrowers consider:

• Rate and term refinance: This refinance option allows you to change the interest rate and loan terms of your current mortgage. Your new loan could ultimately have more suitable terms for your financial situation.
• Cash-out refinance: This type of refinance means taking out a new loan of a larger amount and receiving the difference between the two loan amounts in cash. You can use this cash toward home improvements, buying a second home and more.
• Cash-in refinance: The borrower will contribute a lump sum toward their mortgage to increase equity and decrease the amount owed. This could result in a lower monthly payment and interest rate.
• No-closing-cost refinance: The borrower rolls the closing costs into the principal of the new loan instead of paying them in cash upfront. This makes for a higher monthly payment, but reduces the cash required to close on the loan.

2. Choose A Lender

After you’ve chosen a refinance type, it’s time to choose a mortgage lender. 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 mortgage interest rates, availability and client satisfaction scores.

3. Gather Documents And Apply

When you apply to refinance, your lender asks for the same information you gave when you bought the home. They’ll review your income, assets, debt and credit score to determine whether you meet the requirements to refinance and can pay back the loan.

Some documents your lender might need include the following:

• Two most recent pay stubs
• Two most recent W-2s
• Two most recent bank statements

Your lender may also need your spouse’s documents if you’re married and in a community property state (regardless of whether your spouse is on the loan). You might be asked for more income documentation if you’re self-employed. It’s a good idea to have your tax returns from the last couple of years handy. 

4. Lock In Your Interest Rate

After you get approved, you may be given the option to either lock your interest rate – so it doesn’t change before the loan closes – or float your rate. Each option is unique and has its own pros and cons: 

• Rate lock: Rate locks last 15 – 60 days. The rate lock period depends on a few factors like your location, loan type and lender. You may get a better rate by opting to lock for a shorter period because the lender doesn’t have to hedge against the market for as long. Be warned, though: If your loan doesn’t close before the lock period ends, you may need to extend the rate lock, which may cost money.
• Float rate: 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 of getting a higher rate because it fluctuates But if you’re happy with rates at the time you’re applying, it’s generally a good idea to lock your rate.

5. Go Through Underwriting

Once you submit your refinance loan application, your lender begins the underwriting process. During underwriting, your mortgage lender verifies your financial information and makes sure everything you’ve submitted is accurate.

Your lender will verify the details of the property, like when you bought your home. This step includes an appraisal to determine the home’s value. The refinance appraisal is a crucial part of the 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 money you can get. If you’re trying to lower your mortgage payment, the value could impact whether you have enough home equity to get rid of private mortgage insurance (PMI) or be eligible for a certain loan option.

6. Get A Home Appraisal

Just like when you bought your home, you must get a refinance appraisal before you refinance. Your lender orders the appraisal, the appraiser visits your property, and you receive a professional opinion of your home’s value.

To prepare for the refinance appraisal, you’ll want to make sure your home looks its best. Tidy up and complete any minor repairs to leave a good impression. It’s also a good idea to put together a list of upgrades you’ve made to the home since you’ve owned it.

How you’ll proceed after the appraisal depends on whether:

• The appraisal matches the loan amount: If the home’s value is equal to or higher than the loan amount, it means that the underwriting is complete. Your lender will contact you with details of your closing.
• The appraisal comes back low: If you get a low appraisal, the loan-to-value ratio (LTV) on your refinance could be too high to meet your lender’s requirements. You can choose to decrease the amount of money you want to get through the refinance, or you can cancel your application. Alternatively, you can do a cash-in refinance and bring cash to the table to get the terms under your current deal.

7. Close On Your New Loan

Once underwriting and the 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. It’ll contain 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 loan details and sign your loan documents. You’ll also pay any closing costs that aren’t rolled into your loan. If your lender owes you money (for example, if you’re doing a cash-out refinance), you’ll receive the funds after closing.

Once you’ve closed on your loan, you have a few days before you’re locked in. If something happens and you need to get out of your refinance, you can exercise your right of rescission to cancel any time before the 3-day grace period ends.

You might want to refinance your existing mortgage for a variety of reasons. Let’s look at some of them here.

Change Your Loan Term

Many people refinance to a shorter 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 refinance to a longer term to lower your monthly payment.

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. You’ll likely pay less total interest over the life of your loan as well.

Switch Your Loan Type

A different type of loan or loan program may benefit you for a number of reasons. Perhaps you originally got an adjustable-rate mortgage (ARM) to save on interest, but you’d like to refinance your ARM to a fixed-rate mortgage.

Maybe you finally have enough home equity to refinance your Federal Housing Administration (FHA) loan. You might be able to refinance your FHA loan to a conventional loan and stop paying a mortgage insurance premium (MIP).

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. A cash-out refinance can have tax implications, though.

Learn more about refinancing your mortgage loan and get more mortgage refinance tips by reading the common questions homeowners have about the process.

What does it cost to refinance a mortgage loan?

The total cost to refinance depends on a number of factors like your lender and your home’s value. Expect to pay about 3% – 6% of the total value of your loan. You may not have to pay those costs out of pocket.

In some cases, you can get a no-closing-cost refinance so you don’t have to bring any money to the table. Be aware that closing cost is then paid over the life of the loan in the form of a higher rate.

How long does it take to refinance a mortgage?

Predicting how long your refinance will take can be challenging, but the typical timeline is 30 – 45 days.

When should I refinance my mortgage?

You’ll need to think through a number of factors when deciding if you should refinance. Consider market trends – including current interest rates – and your financial situation (especially your credit score). It’s a good idea to use a mortgage refinance calculator to figure out your break-even point after accounting for refinancing expenses.

You also need to know how refinancing differs from other mortgage options, like loan modification and second mortgages.

Is it better to refinance or do a loan modification?

The major difference between a refinance and a loan modification is that refinancing gives you a new mortgage. Modification changes your current terms to add missed payments back into your balance with the goal of helping you stay in your home. A modification should only be considered if you can’t qualify for a refinance and need long-term payment relief. Modification typically has a major negative impact on your credit score.

Is a second mortgage the same thing as refinancing?

The new mortgage you get from refinancing replaces your existing loan, which is an important distinction between getting a second mortgage and refinancing. Another is that a refinance comes with one monthly mortgage payment, while a second mortgage requires two – your original and second mortgage. While second mortgages typically require lower closing costs, they usually have higher interest rates than a refinance.

Can I reduce my monthly mortgage payment without refinancing?

If you’re interested in lowering your monthly payment, a mortgage recast is a straightforward option. It involves making a significant lump-sum payment on your principal so your lender can reamortize the balance.

How soon after closing can I refinance?

The answer depends on the type of loan you’re getting and the mortgage investor in your loan. It could be as little as 30 days and as long as 6 months or 1 year. How often you can refinance depends on the amount of equity built up and the current mortgage balance.

Will refinancing my home affect my credit?

When a homeowner refinances their mortgage, the lender pulls a hard inquiry and runs a credit report on the borrower’s history. This approval process will lower your credit score but only for a short period. As long as you don’t open any other credit cards and continue repaying any debts you have, your credit score can recover after a few months.

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. You can even cash out your home's equity and use the money as you need it.

Ready to change your loan? Get started with Rocket Mortgage^® by checking out your refinance options and locking your rate today. You can also get started by phone at (833) 326-6018.