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Refinancing a Mortgage

When interest rates are low, you might want to refinance a mortgage loan. Find out when and when not to.

[Updated: Apr 08, 2021 ] Apr 02, 2021 by Laura Agadoni
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Refinancing a mortgage involves replacing your old mortgage with a new one. You do this by applying with your existing mortgage lender for your existing loan or another lender of your choosing. If you’re approved, the new refinanced mortgage takes the place of your current mortgage, and you pay the new mortgage.

Why refinance?

People refinance for several reasons.

Lower the interest rate

If you’re paying a higher interest rate than what you could get if you took out a loan today, you might want to refinance to the lower interest rate. Figure out how much money you can save each month on your monthly payment by refinancing, and balance that with the cost of refinancing (more on that below) to determine whether it makes financial sense to refinance your mortgage loan.

Once you determine your breakeven point -- how long it takes you to recoup the refinancing closing costs -- you’ll have a good idea of whether mortgage refinancing is worthwhile. Generally, if rates drop more than 1% or 2%, you should probably look into refinancing.

Convert from an adjustable-rate mortgage to a fixed-rate mortgage

If your adjustable-rate mortgage (ARM) adjusts to a higher mortgage rate than what you could be paying with a fixed-rate loan, it might make financial sense to do a mortgage refinance.

Change the terms

You could shorten or lengthen the loan term by refinancing. If interest rates fall, you might be able to change a 30-year loan to a 15-year loan with only a slight change in the monthly payments. A shorter loan term will save you considerable money in interest payments.

Or if you want to lower your monthly mortgage payment, you can keep the 30-year loan. Keep in mind that if you had, say, 25 years left on the loan and you refinance, you’ll be back to owing 30 years. By resetting your loan back to the original length, you’ll pay more in interest than you will if you pay the loan off sooner.

Take cash from the equity in the home

Called a cash-out refinance loan, if you have significant home equity, you could replace your existing mortgage for more than what you owe and take the difference as cash. Let’s say your home’s value is $350,000 and you have a mortgage balance of $150,000. You have $200,000 of equity in the home. You refinance your $150,000 loan balance for $200,000 and receive $50,000 in cash. People often do this to make home improvements or perhaps to buy an investment property.

Change an FHA to a conventional loan

Many first-time homebuyers take out a Federal Housing Administration (FHA) loan instead of a conventional loan, maybe because they could get better terms that way, such as putting down less for a down payment, or maybe because their credit score wasn’t high enough to qualify for a conventional loan. FHA loans are great products for those reasons.

But they're more expensive than conventional loans because they require borrowers to pay for mortgage insurance for the life of the loan. To get out of paying FHA mortgage insurance, people often refinance the loan to a conventional loan. With a conventional loan, as long as you have at least 20% equity in the home, you don’t need to pay private mortgage insurance.

Another refinance option available to people with an FHA loan is an FHA Streamline Refinance loan, which allows borrowers to refinance an existing FHA loan to another FHA loan with a lower mortgage rate. Borrowers need to qualify for this refinancing option.

What it costs to refinance

The cost to refinance a mortgage is about the same as the cost to get the original mortgage, typically between 2% and 6% of the loan’s principal. Factors that go into how much the loan will cost include the loan amount, the mortgage lender, your credit score, how much equity you have in the home, and the type of mortgage you’re getting.

If you plan to stay in the home for at least a few more years and the refinance will save you money or allow you to achieve your other goals, it might be worth doing. But if you plan to move shortly, it might not be worth the cost, since you might not reach your breakeven point.

Pros and cons of refinancing

The pro of refinancing is to change the mortgage to more favorable terms for you. (See above.) The con of refinancing is that it costs money.

You’d need to decide whether it’s more expensive to keep your current loan or to refinance. If the pros outweigh the cons, refinancing would probably be a good choice. If the cons outweigh the pros, there’s no reason to refinance.

Steps of refinancing a mortgage

The process of refinancing a mortgage is almost the same as applying for a mortgage to buy a house. Here are the typical steps:

  1. Determine whether it makes financial sense to refinance: Do this by using a refinance calculator to calculate your breakeven point. If you'll be moving before you reach it, it probably wouldn’t make sense to refinance. Otherwise, it probably would.
  2. Find a lender: You can use your current lender, or you can shop around to see whether you can get a more favorable deal from a different lender.
  3. Gather documents: You’ll need to present the same types of documents you presented to get the original mortgage, plus maybe more: proof of income, tax forms, proof of homeowners insurance, copy of title insurance, and proof of your assets.
  4. Apply: Complete the application form, and then follow the lender’s instructions.
  5. Wait: Your application will go to underwriting. If all goes well and you're approved, you’ll get a closing date for your new loan.

How long it takes

Depending on the lender and how busy the market is, it usually takes between 30 to 45 days to be approved, but it could take as long as three months. When rates drop, there’s typically an onslaught of people wanting to refinance. Depending on how busy the lender is and how long inspections and other third parties take determines how long the overall process takes.

Investment property vs. primary residence

If you’re considering refinancing investment property, the process is the same as refinancing your primary residence. The difference is the interest rate for investment properties is usually at least 0.5% higher than for a primary residence. If your investment property loan has a higher interest rate, you might be able to lower the rate to be comparable to a primary residence if you can show you’ve been successfully managing your rental property.

The Millionacres bottom line

Refinancing an existing mortgage is one tool real estate investors use to lower the interest rate, change the home loan terms, or acquire more investment property by getting a cash-out refinance. This can be a great tool to use, but like with anything, run the numbers first.

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