How to Refinance a Mortgage

Guide Note:

So, your adjustable rate mortgage is poised to jump 3 points? Your triplets are heading off to college? Or maybe you have a new kitchen on your mind? There are many reasons for refinancing a mortgage. This guide will help you become aware of the factors involved in the process, so you can make the right decision for you and your family.

Table of Contents:

Refinancing Tips

  1. Compare several lenders.
  2. Calculate the costs involved in applying for this new loan.
  3. Try not to extend the loan term.
  4. Include lost tax advantages when calculating payback.

Disclaimer

The content in this page is not a substitute for professional financial advice. Please contact your financial advisor before using the information presented here.

Introduction

(Creative Commons photo by Raymond)
(Creative Commons photo by Raymond)
  • When you refinance your mortgage, you take out a new home loan and use some or all of the proceeds to pay off the existing one.
  • Read on to how to determine if refinancing is the right step for you to take, and, if so, how to apply for a new loan.

Step 1: Determine if You Should Refinance

  • There are many reasons to refinance a mortgage. The most important thing to remember, though, is to only refinance if it will make sense financially over the long run. Here are some common reasons people refinance:
(Creative Commons photo by Michelle Hofstrand)
(Creative Commons photo by Michelle Hofstrand)
  1. To switch from an adjustable rate to a fixed rate.
    • If you initially took out an adjustable rate mortgage, it can be wise to refinance if rates are going up.
  2. To lower your interest rate.
    • If you took out a mortgage when rates were higher than they are currently, it might be helpful to refinance.
  3. To consolidate debt, ease cash flow problems, or get cash from the equity in your house to use for other purposes, such as college tuition.

Does Refinancing Make Sense?

  • Even if rates are dropping, and all your friends are running to their mortgage broker, refinancing may not make sense in your particular circumstances.
  1. There are costs involved in refinancing. You'll pay fees to get your new loan, and you may owe penalties for leaving your original mortgage.
  2. And even if you lower your monthly payment and remain in your home, if you extend your loan term, you may wind up paying more in the long run.
    • If you can afford your current monthly payments, you could be better off paying down your current loan rather than refinancing.

Costs Involved with Refinancing

  • Refinancing can mean paying points and other closing costs. Some of the costs you may encounter are:
  1. Points
    • Points are essentially prepaid interest to the lender. One point equals 1 percent of the amount you're borrowing.
    • The more points you pay up front, the lower the interest rate.
  2. Loan Origination Fee, generally .5 - 1% of the loan.
  3. Appraisal Fee
  4. Title Search and Title Insurance
    • This protects the lender, not you. You may be offered an opportunity to purchase title insurance, at an additional fee. If you purchased it with the original mortgage, you don't need to buy it again.
  5. Other fees associated with processing and finalizing the mortgage, such as recording, document preparation and copying. You may also be charged an application fee.

NOTE: There are times when lenders offer "no points, no closing costs" refinancing deals. Check the terms of the offer carefully to make sure that you understand what's involved. These usually carry a higher interest rate, but may make sense financially, depending on your individual circumstances.

Step 2: Find A Lender

  • Of course, you can't decide whether or not to refinance until you learn the loan terms lenders are willing to give you. You'll want to identify several potential lenders, and ask each for quotes. Make sure the loan details they provide include an interest rate, term, and all related costs.
  1. You should approach your current lender about refinancing.
    1. The process may be more streamlined.
    2. They may waive some of the closing costs.
    3. You may not always get the best deal right away. Make sure they know you will be shopping around.
  2. Talk to your bank.
    1. Banks you have a relationship with are already familiar with you and your credit history.
    2. If the bank holds its own loans, they may have more flexibility with terms.
  3. Mortgage Broker
    (Creative Commons photo by Alan Turkus)
    (Creative Commons photo by Alan Turkus)
    • A mortgage broker has access to many different lenders and products.
    • You can find a broker by personal or professional referrals.
    1. Ask friends and business associates for the names of brokers they've worked with.
    2. Your accountant or attorney may also have suggestions.
    3. A local real estate agent will have worked with many brokers, and may be your best referral source.

NOTE: Your lender is required, under federal law, to provide you with an estimate of the costs you'll pay for the loan, called a Good-Faith Estimate, within three days of receiving your application. If you've received any previous estimates, make sure to compare them to the "Good-Faith Estimate" when you receive it.

Step 3: Calculate Your Savings

  • Once you've collected quotes from multiple sources, you'll want to choose the best loan, by figuring out how much money, if any, each offer will save you. You can use online tools to do this, like the ones from:
Calculate the cost of refinancing before applying. (Photo by Svilen Murad)
Calculate the cost of refinancing before applying. (Photo by Svilen Murad)
  1. CNN Money: Refinancing Calculator
  2. Bankrate.com: Will you save by refinancing your mortgage?
  • You can also do the calculation yourself, with the method outlined below.

Cash Flow Payback Period

  • Once you've determined what your refinancing costs will be, you can then determine how long it will take for your refinancing to pay for itself.
  1. Total the costs you will pay for the new mortgage.
  2. Calculate the monthly savings on your new mortgage.
  3. Divide your costs by the net monthly savings that the new loan provides you.
  4. This figure is the number of months it will take you to recoup your costs. If you will be staying in the house for at least that many months, it may make sense to refinance.
Calculation of Lost Tax Advantage
  • Here's a simple way to approximate the tax advantage you'll lose when you refinance at a lower interest rate. It's not precise, but will give you a general number you can use for this analysis.
  1. You'll need two numbers from your last tax return: Your "Taxable Income" and your "Total Tax".
  2. Divide the Total Tax by the Taxable Income to get your tax rate. (So, if your Taxable Income is 80,000 and your Total Tax is 16,000, your tax rate would be 20%.)
  3. Next you need the monthly interest portion of your current payment, as well as the monthly interest portion of the new payment.
  4. Take the difference between the two, and multiply it by the Tax Rate.
  5. This number is lost Tax Advantage that your new loan results in. Subtract it from your monthly savings for a more accurate assessment of the costs of your new loan.

Be Careful With the Loan Term

  • One last caution: even if you're getting a lower interest rate, you may wind up paying more interest over the life of the loan if you aren't careful with the loan term.
  1. For example, if you're seven years into a 30-year mortgage, and you refinance for another 30 years—you'll be paying interest for an additional seven years.
  2. If your cash flow can handle it, try to keep the term you refinance for at or below the number of years remaining on your original mortgage.

Step 4: Apply for Refinancing

  • If you've decided that refinancing is for you, you'll need to apply for your new loan. The refinancing application process is pretty much the same as the original mortgage process. Although some lenders have streamlined programs that promise quick approvals, the average process takes about four weeks.
(Photo by Jan Stastny)
(Photo by Jan Stastny)
  1. Many lenders will allow you to apply by phone, or online, rather than complete a paper application.
    • A paper application is still filled out, but the loan officer completes it with the information he obtained from you.
    • You'll be required to review and sign the application before the closing.
  2. As part of the application process, the loan officer will request a review of your credit score.
  3. You may need to provide some documents that verify your income, such as a W-2, or, if you're self-employed, copies of your tax returns.
  4. An appraisal of the property will also be done.
  5. Once the application is complete, the loan officer sends it to the underwriter for review.
  6. If everything looks good, the underwriter will approve the loan.

Additional Tips

  1. You will probably be required to furnish ID at the closing. Make sure to bring your driver's license, no matter how well you know the lender.
  2. If there is a balance due when you close, you may need to pay with a cashier's check.
  3. By federal law, you have three days after you close to cancel the contract.
    1. This can be useful if circumstances change—for example, you find out you're being transferred out of state, and will be selling the house, or interest rates fall steeply.
    2. Sometimes you may discover a clause in the documents you signed at the closing that you're not comfortable with. The right of rescission means you can cancel the contract, and not be bound by the clause.

Conclusion

  • With a real estate market that's constantly in flux, it can be hard to determine whether or not to refinance your mortgage. But if you keep in mind the costs associated with refinancing and how long your new mortgage will run, you'll be able to make the right decision for your wallet, your home, and your family.

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Resources for How to Refinance a Mortgage