Refinancing Your Mortgage Loans 101

February 12, 2019 by Comerica Bank

For many Americans, a mortgage is more than just a loan used to purchase a home. It's a ticket to long-term financial stability and represents a wise investment.

The 30-year fixed-rate mortgage has been the gold standard among U.S. homebuyers because it allows them to lock in their interest rate and easily budget for their monthly housing expenses. A smaller percentage of the population may also consider an adjustable rate mortgage (ARM) loan. ARM loans typically have a lower starting rate and may make sense for some borrowers with a shorter timeline. 

At the same time, mortgages allow for some flexibility. For instance, you can refinance your existing mortgage. Should plans change over the years, or if borrowers just want a better deal on their home loans, refinancing makes it possible. If you are considering refinancing a mortgage, it pays to find the right lender for your needs and to come prepared with a good understanding of the process.

What is refinancing?

Unless the terms specify a prepayment penalty or explicitly prevent it, most loans can be refinanced. Essentially, refinancing involves taking out a new loan to pay off the remaining balance of an existing loan. Ideally, the refinanced loan will benefit the borrower in some way compared to the previous arrangement. Common objectives or reasons to refinance include:

  • To secure a lower interest rate.
  • To lower monthly payments.
  • To pay off the loan faster.
  • To help pay off higher-interest debt from credit cards or personal loans.

How do I refinance my mortgage?

Since refinancing is similar to getting another mortgage, the application process and some of the fees involved should be familiar. Start the process of refinancing your mortgage by understanding your goals and options for refinancing, and by carefully weighing the benefits and costs.

Understand your refinancing options and objectives

As previously discussed, homeowners who refinance do so to either save money on their mortgages or to free up additional cash. Your ability to accomplish either of these objectives with your own refinanced loan will depend on several key financial characteristics, including: 

  • Your outstanding loan balance, or how much of your mortgage is left to repay.
  • The current market value of your home.
  • The prevailing market interest rate on home loans.
  • Your credit history.
  • Information about your income and total net worth.

Some of these details concern the homeowner's financial situation, while others, like the value of the property or current interest rates, reflect broader economic trends. These factors all combine to influence the most likely outcome of refinancing depending on your goals.

For example, if interest rates have gone down since you signed onto a fixed-rate loan, you may now be able to refinance and save some money using a new loan. Or, if you have made timely payments for years while the value of real estate in your area has risen, it may be possible to leverage your accrued home equity into cash (also known as a cash-out refinance). Therefore, you should research and set a goal accordingly to understand what's possible with your mortgage refinance.

Gather data and paperwork

It's easier to apply for the right mortgage refinance program when you have all the requisite information at the ready. Take time to research your financial situation and gather important documents that will expedite the refinancing process once you're ready to apply. 

  • Get a status check on your mortgage: If you haven't already, review recent statements from your current mortgage provider to understand the rate you've been paying and the remaining balance on the loan. Gather essential information on your mortgage account, including any ID numbers and how to contact the lender. When applying for a refinance, you may need to provide a payoff statement from the current lender, which will detail the costs involved in closing the loan using funds from a refinance. You may also have a second mortgage or Home Equity Line of Credit outstanding.
  • Check your credit: Just like many other financial products, your refinanced mortgage's interest rate and terms can be influenced by your credit score, and refinance lenders will take a close look at your entire credit history while reviewing your application for a new loan. Take time to review your credit to ensure there are not any glaring errors or negative marks.
  • Estimate your equity: Home equity is the difference between your property's fair market value and what you still owe on your mortgage(s). The more equity you have in your home, the less of a risk you pose to refinancing lenders. However, a home's market value has more to do with the general economy and the price of similar houses nearby, rather than any factors that homeowners can control. Still, it helps to get an estimate on your home's market value to understand your equity situation, which may then influence the interest rate and terms on your refinanced mortgage.
  • Gather important documents: Refinancing your mortgage is not unlike applying for any other home loan. That means the new lender will probably require the same sizable stack of paperwork to verify your identity and financial information. Prepare copies of recent pay stubs, bank statements, tax returns, the deed or title to the property and other essential financial documents. When applying for a cash-out refinance, make sure to provide a document that formally explains how you will use the funds. You may be able to provide electronic copies of many items.

Certain states may have additional requirements or restrictions related to mortgage refinancing that will require additional documentation. Work closely with your refinance lender to ensure you have everything needed to move forward.

Estimate fees and costs

Refinancing a mortgage does include various transaction costs that need to be accounted for. Like closing costs on a home purchase, home loan refinancing requires some payments upfront related to applying for the new loan and closing the old one. Borrowers who refinance their mortgages may also need to pay property taxes, insurance premiums and a few other one-time fees by the time the deal is done.

The best way to estimate how much a mortgage refinance will cost is to take some time to crunch the numbers first. Calculate how much interest you've already paid on your mortgage as well as how much you still need to pay, then compare that to any quote or estimate you've received for a refinanced loan including fees. 

Remember that the lifetime cost of any loan is a factor of its interest rate as well as the term length. Generally, the sooner you can pay off the loan in full, the less money you will end up paying overall. This means that if you do refinance your mortgage, you need to strike the right balance between monthly costs and the total cost over the life of the loan. It may actually make sense to increase your monthly payment under a refinanced mortgage if you can fit it into your monthly budget, since this tends to reduce the amount of interest that is charged. On the other hand, you might prefer to lower your monthly payment at the expense of higher lifetime costs, thus allowing you to devote more cash to other expenses.

Cash-out refinancing and debt consolidation

Using a cash-out refinance, it might be even easier to address short-term cash flow problems. A cash-out refinance is similar in concept to a home equity loan, except it actually replaces the borrower's mortgage with a new one worth more than the borrower's outstanding debt. This allows the lender to extend a lump sum of cash equal to a portion of the homeowner's available equity. That cash can then be used to pay off higher-interest debt, such as that from credit cards or other loans.

However, compared to a standard mortgage refinance, cash-out refinancing plans tend to incur higher interest rates and additional fees. Alternatively, if debt consolidation is the primary goal, a refinancing lender may be able to structure a standard refinanced mortgage to enable smaller monthly payments and more free cash flow to commit to other debt obligations.

To get a complete understanding of your mortgage refinancing options, speak with the experts at Comerica Bank today. 

 

This information is provided for general awareness purposes only and is not intended to be relied upon as legal or compliance advice.

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