How to Refinance Your Mortgage
Who should consider refinancing?
How to refinance, in 5 steps
Mortgage interest rates have been setting record lows over the last few months. In mid-October, we hit the tenth record low this year. As of October 15, the average mortgage rate on a 30-year fixed-rate mortgage stood at 2.81%, the average rate on a 15-year fixed-rate mortgage was 2.35% and the average rate on a 5/1 adjustable-rate mortgage (ARM) was 2.9%.
Such low rates make it a great time to refinance your mortgage and potentially save hundreds of dollars a month in interest payments. If you used those savings to pay down your new mortgage faster, you could be debt-free five to 10 years sooner and have the ability to retire earlier.
Let’s back up a bit and go over some basics.
What does it mean to refinance your mortgage?
In short, refinancing means you’re replacing your current home loan with a new one. The new mortgage will have different terms and interest rates.
It’s a strategy people use for various reasons:
- To reduce their mortgage interest rate, which will cut their monthly mortgage payments payments
- To take out cash from their home’s equity (this is called a cash-out refinance) and use it for remodeling costs or to buy another property
- To pay off their loan faster by switching from a 30-year to a 15-year fixed rate mortgage (this means you’ll owe less interest over the life of the loan and be debt-free faster, but your monthly payment will likely go up)
- To switch from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage (with an ARM, your rate can increase or decrease, while a fixed-rate mortgage locks in your interest rate for the entire term of your loan)
Refinancing means you have to qualify for the new loan, just like you had to qualify for your original mortgage. Like you did when you first bought the home, you’ll have to file an application, go through the underwriting process and close on the loan.
Who should consider refinancing?
If you have a mortgage right now, can lower your rate by 0.5% or more and plan to be in your home for more than three years, I strongly encourage you consider refinancing. On a 30-year mortgage, if your balance is over $250,000, there’s a good chance you could save over $50,000 during the life of your loan, but use a refinance calculator to run the numbers yourself.
Keep in mind that refinancing does come at a cost. Fees, including the origination fee, application fee, home appraisal, underwriting fees, etc., can cost anywhere from 2% to 6% of your loan amount. Refinancing only makes sense if the savings you enjoy from lower interest payments more than cover the cost of closing the new mortgage.
If you’re going to be in your home for at least another three years, you’ll generally come out ahead if your new interest rate is one full percentage point lower than what you are currently paying. Do a “break-even analysis” using a refinance calculator to see at what point the savings will actually be greater than the closing costs. It’s important to know this before you commit to refinancing.
How to refinance, in 5 steps
If refinancing makes sense for you, follow these five steps:
1. Establish your specific goal with refinancing. Make sure you’re clear on why you want to refinance. Is your goal to lower your monthly mortgage payments? If you currently have an adjustable-rate mortgage, do you want to capitalize on the low rates right now and lock in a fixed-rate mortgage? Do you want to shorten your loan term and become debt free faster?
Setting a clear goal will help guide you through the process. If you want to lower your monthly payment, for example, you’ll want to shop for a lower interest rate (and make sure the savings on interest outweigh the fees associated with refinancing). If you want to pay off your mortgage sooner, you’ll want to refinance your 30-year mortgage into a 15-year mortgage.
2. Understand where you’re at financially. Start by pulling your credit report (you can get a free one at www.annualcreditreport.com) and looking at your credit score. Not only can you look over your report for any errors (and head them off), but you can also get an idea of what type of mortgage rate you’ll qualify for. (The better your credit, the better your odds of scoring a lower rate.)
You’ll also want to pay attention to your debt-to-income ratio, or DTI. Mortgage lenders want your DTI to be less than 38%. That is, your monthly mortgage payments shouldn’t total more than 38% of your monthly income.
Lenders will also consider your loan-to-value ratio, or LTV. Most lenders want it to be less than 80% — meaning, the total amount you owe on your house should be no more than 80% of what the house is worth. For example, if your house is worth $200,000, they typically won’t refinance a mortgage or more than $160,000.
3. Compare multiple mortgage refinance lenders. To get the best mortgage refinance rate, call up multiple lenders. Don’t talk with your current loan officer before getting a quote from another lender. There are thousands of dollars at stake, so make lenders fight over you. Be transparent. Let the banks know you’re shopping around and that you want to act quickly. This forces them to give you a competitive rate or risk missing out on your business.
When you compare mortgages, you will need to take note of the annual percentage rate (APR), whether the lender is charging you “points” up front (these are essentially fees and you want to avoid them or at least negotiate them) and what the closing costs will be (including fees for appraisals, title search, title insurance, credit reports, etc.).
To help you start the comparison process, I put together a list of some of the best mortgage refinance companies.
4. Apply for a mortgage. Apply with three to five lenders and submit your applications within at least a two-week period. Ideally, you’ll submit them on the same day. Shopping and comparing loans on the same day levels the playing field, as you’ll be comparing loans on an apples-to-apples basis. Plus, you’ll minimize the impact on your credit score. When lenders check your credit, it results in a “hard inquiry” on your credit report and too many hard inquiries can negatively impact your score — if you submit all your loan applications around the same time, though, it should just count as one hard inquiry.
When applying, ask the lenders what advice they can share to ensure your application gets approved. The lender wants to approve and close your loan. They are in the business of doing just that, so don’t fight the process. Get your lender what they need, as fast as they need it.
On that note, be prepared to provide certain documents. You may be asked to show a copy of your credit report, proof of income (in the form of pay stubs or tax forms), statements of any debt you owe and homeowners insurance information.
5. Pick the best lender and close on the loan. Once you’ve been approved, look over all of the details from each lender. Don’t zero in on the interest rate when deciding which lender to go with — you want to look at what your projected payments will be, closing costs and other fees
Once you settle on a lender, all that’s left to do is close on the loan. You’ll pay the closing costs and have a new mortgage.
Keep in mind that it’s getting tougher to refinance. Banks are swamped with business and many are also looking for a high credit score. The time to act is now.
The No. 1 mistake I see people make when refinancing their mortgages is putting it off in hopes that rates will go lower. Mortgage rates shift daily and can be affected by a variety of factors. Right now, they’re low, but that won’t last forever.
Want to be coached on how to do all of this quickly and easily? Sign up for my FREE popular online course, The First-Time Homebuyer Challenge.