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Not in the right type of loan?
Find out more about mortgage refinancing
by Chris Kissell
If your home loan is not everything you’d like it to be, consider a mortgage refinance.
A refinance is the ultimate home loan “do-over.” Essentially, when you refinance, you pay off a current home loan and take on a new one.
In some cases, a refinance lets you dump your current mortgage rate and lock in a lower rate that could reduce your monthly mortgage payments.
In other cases, a refinance lets you “cash out” and use the equity in your home for things like home renovations.
Why You Might Refinance
People take out refinance loans for many reasons. Here are a few of the most popular ones.
Lowering monthly mortgage costs. If mortgage rates have dropped since you took out your current loan, it might make sense to refinance into a new loan with a lower interest rate. Or perhaps your credit has improved significantly since you took out your home loan. If so, you might qualify for a new mortgage at a lower rate.
Switching to new mortgage terms. Mortgage loans come in different flavors, and the loan term that suited you best when buying your home might not serve you as well today. For example, maybe an adjustable-rate mortgage (ARM) made sense a few years ago, but now you’d like the stability of a fixed-rate mortgage.
Perhaps you want to switch to a mortgage with a longer term, which usually helps lower your monthly payment. Or maybe you want to switch to a mortgage with a shorter term, which typically comes with a lower rate.
Freeing up cash. A cash-out refinance lets you tap your home equity – the difference between how much you owe on your mortgage and the monetary value of your home.
If you refinance for a loan amount that’s larger than what you owe on your mortgage balance, you receive this difference in cash. This cash can be put toward a big-ticket item like major home improvements.
How a Refinance Works
If you’re considering a refinance, you first should check your credit report. You need a solid credit score to get the best possible mortgage rate and terms; mistakes on your credit report can sabotage hopes of getting a great rate. In fact, a poor credit score might sink your hopes of getting a refinance at all.
Federal law gives you access to one free credit report every year from each of the major credit bureaus – Equifax, Experian and TransUnion – through AnnualCreditReport.com.
When you’re ready to shop for a mortgage, talk to your current lender. The lender might give you a break on refinancing fees to keep your business if you’ve been a good customer.
However, it’s smart to shop around and compare offers from other lenders in order to get the best deal. When you seek refinancing from a lender, you’ll receive a loan estimate that breaks down costs such as:
- Interest rate
- Monthly payment
- Closing costs
The loan estimate also includes other important information, such as how the interest rate and payments can change over time.
Federal law requires that all lenders use the same loan estimate form. This makes it easier for you to compare the terms being offered by various lenders.
Things to Consider Before Refinancing
Refinancing to lower your rate often is wise. But a lower rate might not be enough of a reason to take the plunge.
“Many lenders will offer you a very attractive rate, but that could come at the expense of high fees,” says Glenn Brunker, mortgage executive at Ally Home, the direct-to-consumer mortgage arm of Ally Bank.
Examples of costs that might be rolled into the loan include:
- Origination fee
- Underwriting fee
- Processing fee
“You will have to likely have to have an appraisal done, which can cost you several hundred dollars, around the same time you apply for the loan,” Brunker says.
It’s not unusual to pay 3% to 6% of your outstanding principal in refinancing fees, according to the Federal Reserve.
If you plan to move out of your home within the next few years, you might not have enough time for the savings from your new lower monthly payment to outweigh such costs. The idea is to save money, after all.
Also, some mortgages come with a prepayment penalty that lenders charge if you pay off the loan ahead of time. If your current mortgage comes with a prepayment penalty, it might be steep enough to steer you away from refinancing.
A mortgage refinance can benefit many homeowners. But it’s important to look before you leap.
“It’s critical to look at how much it will cost you to get the refinance, as well as the total cost over the life of the loan,” Brunker says