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Home Refinancing Guide: How Homeowners Refinance a Mortgage

October 14, 2020

19 MINUTE READ

Whether you want to lower your monthly payment, shorten the length of your loan or access some of the equity you’ve built up in your home, there are a number of excellent reasons to refinance your mortgage.

As long as you know what to expect, refinancing your home is simpler than getting a new mortgage and it doesn’t need to be stressful or overwhelming. Let Reali Loans give you with the knowledge you need to enjoy the process and achieve a financially beneficial outcome.

Important Note: This refinance guide is an educational resource for borrowers. Not all of the products mentioned in this guide are offered by Reali. We think it’s important that you know all of your home loan options in order to make the most educated, informed decision possible.

Refinancing a mortgage is when you pay off one home loan by using another home loan.

Should I refinance my mortgage?

When you’re ready to refinance your house, you stand to unlock many potential benefits. These are called “net tangible benefits” and under conventional lending, the lender must show that you, the borrower, is receiving a net tangible benefit in order to move your refinance forward.

There are a variety of great reasons to refinance:

  • Lower your monthly bill (this can be done by casting the loan over a longer term, starting a new term, or by going with a lower interest rate)
  • Secure more favorable terms (e.g. fixed vs. adjustable interest rate)
  • Lock in a lower interest rate
  • Get access to cash for a large expense or to pay off higher-interest debt
  • Change mortgage companies
  • Remove someone’s name from your mortgage

It’s really that simple. Of course there are details — a lot of details, honestly—but we will help you understand them one by one, so you can refinance with confidence. If you have specific questions along the way, please reach out to our Reali Loans team. Our experts are standing by with the home loan answers you need at, 1.855.846.7334.

Everyone is different, so let’s discuss the reasons it may make sense for you to refinance your home.

Lower your monthly payments

Tired of feeling overwhelmed by your current monthly mortgage payment? Want to lower your payment so you can use the money elsewhere? A loan refinance can help. Reduce your monthly payments by securing a lower interest rate or by increasing the number of months you have to repay the loan (or both).

Lowering your interest rate without extending the loan saves money both in the short- and long-term. Your payment will be lower, and the payoff date remains the same.

A new mortgage with an extended repayment period can also reduce your monthly bill, since extending the repayment period would spread the total amount you owe by more months to pay it back. The potential downside? Extending the loan term generally means paying more interest over the life of the mortgage.

Lower your interest rate

When you first purchased your home, your bank or lender drew up a mortgage agreement based upon your financial situation at the time. If you were a younger buyer, you may not have had the time or experience necessary to secure an outstanding credit score—so your rate may not have been ideal. Plus, lower rates may now be available if market conditions have improved.

Mortgage lenders don’t like risk, so they hedge their bets. One way they do this is to assign higher interest rates to mortgages for borrowers who are viewed as risky. The good news is, you may be seen as a lower risk today than you were a few years ago, and you may qualify for a lower rate. 

Increased interest cost over the life of the loan may be worth it to you if you need more cash in your monthly budget right now.

There are a few standard refinance loan categories you should know about. 

Cash-out refinance

A cash-out refinance is a way to convert home ownership into spendable cash. The loan is made against the equity (e.g. outright ownership) you have in your home. You get cash and a bigger loan.

Rate and term refinance

A rate and term refinance is the refinancing of an existing mortgage in order to change the interest rate and/or other loan terms without advancing any new cash to the borrower.

For example, if interest rates go down, you might refinance at the lower rate. Or if you have an adjustable rate loan, you might want to refinance to a fixed rate.

Fixed or adjustable-rate mortgage

In a fixed rate mortgage, your interest rate is “locked in,” meaning that changing market conditions will not affect the monthly amount you pay in interest.

The advantage of a fixed rate mortgage is clear: if interest rates in the mortgage market go up, you will not pay more as a result. And right now, rates are excellent. 

The potential disadvantage is obvious—if interest rates in the mortgage market go down even further, you will still be locked into paying the higher rate you accepted at the start of your mortgage.


Government-backed loans

A government-backed mortgage is a home loan that is guaranteed by the federal government.

When you borrow money from a private lender that issues you a government-backed loan, the government guarantees repayment to that private lender in case you fail to pay the lender back.

The most popular types of government-backed mortgages are the FHA loan, the VA loan and the USDA loan, all of which have different eligibility requirements and limitations.

Why does the government guarantee loans? Because lenders don’t like financial risk, so they may charge a high interest rate, present very stiff repayment terms, or refuse to make a loan—all in an effort to minimize the possibility of losing money. This is especially the case when dealing with borrowers who have limited financial resources.

Many government programs are available to help guarantee home loans for middle to lower-income buyers, perhaps most notably through the Federal Housing Administration (FHA).

The government promotes homeownership, because homeownership is good for the economy. That’s why the government makes repayment guarantees to help private lenders sleep at night. Which, in turn, helps you convince those lenders to loosen up their purse strings—it’s a win-win.

Most mortgage borrowers apply for a 30-year mortgage. If that’s you, you’ll be paying the lender back, with interest, in monthly installments over a period of 30 years.

The 30-year mortgage is so common that many borrowers don’t realize there are alternatives. The most common being the 15-year mortgage (but the actual loan term can be whatever number of years you agree upon with your lender).

A 15-year mortgage is just like a 30-year mortgage, except that you pay back the loan in half the time. This raises the monthly bill, but not by as much as you’d think. Even though the loan period is cut in half, the amount you pay doesn’t double. In fact, the payment tends to be only about one-third higher. So, the borrower saves big interest costs over the life of the loan.

Since you are borrowing the money for half the time in a 15-year mortgage, you will pay less than half of the interest you would pay to borrow the same amount for 30 years. So, if you can afford a slightly higher month-to-month payment, a 15-year mortgage is a much better deal.

In addition to 15- and 30-year loan terms, Reali Loans also offers 10-, 20- and 25-year terms. Call us to find out which plan makes the most sense for your budget and goals at 1.855.846.7334.

Qualified mortgage

A qualified mortgage is any home loan issued by a private lender according to federal standards that protect mortgage borrowers from lending practices that are deemed predatory or unfair.

In order for a loan to be considered a qualified loan, the lender must follow federal guidelines that forbid excessive fees and repayment terms that are difficult for borrowers to sustain (among other guidelines).

Conventional mortgage

A conventional mortgage is any home loan that isn’t created or backed by the federal government. Conventional mortgages are created and backed by private lenders or government-sponsored enterprises, such as Fannie Mae or Freddie Mac.

Today, most mortgages are sold. In order to be eligible for purchase by Fannie Mae or Freddie Mac, the loan must be a conforming mortgage and meet certain requirements.

The biggest difference between conforming loans and non-conforming loans is that conforming loans have a dollar limit. In 2020, the dollar limit on a conforming loan for a one-unit property is $510,400. In certain high-cost housing areas, that limit is increased by up to 150%.

A jumbo loan is a loan that exceeds conforming loan dollar amount limits.

If you’re planning to take out a sizable loan for a home improvement project, a child’s education, or for any other reason, then a cash-out refinance might be a good option. A cash-out refinance converts the equity you’ve built up in your home into spendable cash.

For example, consider your original mortgage from a few years ago if the value of your home has gone up since then:

  • Purchase price: $200,000
  • Original loan amount: $160,000 at 4.0%
  • Current appraised value: $240,000
  • Number of payments made: 60
  • Current outstanding loan balance: $145,000
  • Your current equity: $95,000

As you’ve been paying down your mortgage, the value of your home has increased. In both ways you have been establishing equity in your home.

Equity means “degree of outright ownership.” Simply put, equity is the current value of your home, minus the amount you still owe.

That $95,000 equity is essentially your money, but instead of sitting as cash in your bank account, it exists in the market value of the bricks, mortar, and land that make up your home.

A cash-out refinance converts that equity into spendable cash—without you having to sell your home.

The amount of cash you can access depends on the loan-to-value limit set by the lender. If the lender allows a 80% LTV, in our scenario, you could take $47,000 in cash. That amount would be added to the amount you already owe, for a new loan of $192,000.

Take someone off the loan

In some situations, you may want to remove one person from a loan that two people are currently responsible to pay. Divorce is a common reason to do this and growth—buying another property or financing a large purchase—is another. 

When a borrower is removed from a loan it means that person is no longer obligated to the monthly payment. Their borrowing power then increases because the debt no longer factors into his or her debt-to-income ratio.

The most common way to remove yourself or someone else from a mortgage is for the remaining borrower to refinance the loan in their name only. This borrower will need to qualify for the loan independently.

Change from an adjustable to a fixed rate (or vice versa)

With a fixed-rate mortgage, the interest rate stays the same during the life of the loan. An adjustable-rate mortgage is just the opposite—the rate goes up or down along with an index rate (there are many different index rates used by lenders).

Adjustable-rate mortgages (ARMs) typically come with a lower rate and lower monthly payment during the early years of the loan (the first five years, for example). If you’re a borrower who plans to sell the home or pay off the loan within that time frame, this is a great option. However, once benchmark rates begin to rise, an adjustable-rate borrower who does not sell the home or pay off the loan may save money by refinancing with a fixed-rate loan.

If you already have a fixed-rate mortgage, you might be spending more money than necessary. Like anything financial that fluctuates with the market, an adjustable-rate mortgage involves a degree of risk, but it may make sense depending on your financial situation, your plans, your current mortgage terms, the new loan terms and other factors.

When you’re ready to refinance, you can master the basics in no time. Preparation is key when it comes to making sure the application process goes smoothly. From determining if refinancing is for you, to comparing lenders and gathering the necessary documents, the more boxes you check off upfront, the less stress you’ll experience during the refinancing process. Here’s what you’ll need to have ready to refinance your home:

Determine your credit score

Make sure to check your credit report and clear up any problems at least 60 days before starting the mortgage refinancing application process. Problems with your credit report could hurt your chances of securing the loan you want on the most favorable terms possible.

If you have a credit dispute, most lenders won’t start the loan application process until it is settled.

Appraise your home’s value

In order to issue a new loan, your lender will need to know your home’s value and how much equity you have in the home.

The first step in calculating equity is to determine how much your property is worth. You can get a general idea by checking sites like Zillow. As you run the numbers, it’s a good idea to lean toward the low range of the potential property value. Your lender will send a professional appraiser to determine the actual value for loan purposes and it may not be the same as the value you find online.

You’ll be responsible to pay to have your home appraised by a professional that your lender trusts. You will not get to choose who appraises your home.

During appraisal, make sure your home is looking its best. After the appraisal is complete, you’ll receive a document that estimates the current value of your home.

Shop around for a loan

You can apply with as many mortgage lenders as you want within a short period of time—without risking damage to your credit score from multiple inquiries. The rate-shopping window is 14 to 45 days, depending on the credit scoring model chosen by your lender.

Review your loan estimate

Once a potential lender accepts your loan application, they have three days to offer you a Loan Estimate, which shows the details of the loan they are offering you. Federal law requires lenders to give Loan Estimates in a standardized format designed to help borrowers compare one offer to another, side by side, to avoid unnecessary confusion.

Refinance with bad credit

If you’ve got bad credit, you should still research refinancing. Determine whether your credit is good enough to qualify for a loan that is satisfactory. If not, here are some of your options:

  • Spend six months improving your credit, and try to get into the next higher credit score range
  • Ask a cosigner with better credit to help you secure better terms than you can get on your own
  • If you have an FHA loan, you may qualify for an FHA streamline refinance, which may not require a credit check or verification of your income and assets (depending on the lender)

You’ll need to provide many documents to your lender, unless you can do an FHA streamline refinance. The following checklist will give you a general idea of what to gather, but your lender will give you its own list.

Personal

  • Divorce or separation decree
  • Transcripts or diploma (if you don’t have two-years employment)
  • Current housing documents (mortgage information)

Financial

  • Tax papers
  • Bank account information
  • Assets information

Employment

  • Employer verification
  • Income verification
  • Self-employment documentation

Home

  • Rental property information
  • Deed
  • Title Insurance
  • Homeowner’s insurance

There are some costs involved with every home loan. In some cases, the lender absorbs those costs (often because it charges a higher APR), and in other cases the costs will roll into the loan amount. The latter is sometimes called a “no-cash” mortgage.

Refinance costs and fees

Even with a lower rate, a loan that comes with very high fees may be less worthwhile than it initially seems. The best way to uncover any hidden costs of a refinance is to run the numbers with potential mortgage lenders before you make a decision.

The good news is: lenders will likely compete for your business. Even when refinancing fees are factored in, you may still be looking at a substantial savings over your current mortgage.

That said, there are two things you need to know before considering a mortgage refinance: 1) the closing costs, and 2) the break-even point.

Reali is different. Unlike traditional banks and brokers, we don’t charge fees. Specifically, we don’t charge origination fees (unless you buy down points), application fees or credit-pull fees.

Cost of closing

Refinancing your mortgage may save you money over time, but the process itself can be costly.

You can typically expect refinancing fees to cost between 3 to 6% of the outstanding balance on your original mortgage. In some instances, you will need cash on hand to close the loan. In other cases, you will have the opportunity to roll those costs into the loan balance. If you do that, you will pay interest on those costs for the life of the loan.

Break-even point

The break-even point is when your cumulative savings equals the cost of your loan. Plan to keep your home for at least long enough to reach the break-even point, otherwise refinancing may not be a good option for you.

For example, if the cost of your loan is $5,000 and your monthly payment is lowered by $100 per month, you will reach your break-even point after your 50th payment, in a little over four years.

Insist on full transparency and ask for a detailed explanation of every fee the lender charges, so you never feel blindsided by unexpected, confusing fees. 

As a direct lender, Reali Loans is able to cut out the middleman and reduce fees. Our home loan experts are available to answer questions over the phone and provide you with a 100% honest experience.

Here are some of the most common refinance fees:

Origination fee: This fee covers the cost of processing the loan.
Reali Loans does not charge an origination fee unless the borrower chooses to buy discount points.

Discount points: Paying discount points is the same as paying interest in advance. You can choose to pay this voluntarily, in order to reduce your monthly interest rate. The lender benefits by receiving money upfront, and you benefit by buying down your interest rate.

Each discount point costs 1% of the total loan amount, but can save you a lot of money over time—usually ¼ of one percent for each discount point you purchase. This may not sound like much, but it can really add up.

For example, if you have a $200,000 mortgage with a 4.5% APR, two discount points would cost you $4,000 out-of-pocket, but save you $21,074 over the life of a 30-year loan. That’s a great return on your investment!

Application fee: This is a catch-all term used to refer to a collection of fees—like the origination fee, appraisal fee, underwriting fee, document preparation fee, credit report fee, broker fee, and so on. If your lender lists an application fee, make sure to request the details about which individual fees it covers and which ones are negotiable.

Reali Loans does not charge application fees.

Underwriting fee: This is a fee paid to the lender for doing the work to process your loan application.

Reali does not charge an underwriting fee.

Fees for services you cannot shop for:

  • Appraisal fee
  • Credit report fee
  • Flood determination/certification fee
  • Tax monitoring fee
  • Tax status research fee
  • Even some services you cannot shop for may be negotiable

Fees for services you can shop for:

  • Pest inspection
  • Title insurance
  • Settlement agent fee
  • Title search
  • Hazard/homeowners insurance

Potential additional fees: 

  • Document preparation fee
  • Administrative fees
  • Funding/wiring fee
  • Survey fee
  • Mortgage broker fee
  • Notary fee
  • Release of lien fee
  • Attorney fee
  • Courier fee
  • Recording fees
  • Tax stamps
  • Property taxes

As a borrower, make sure you know about “fee tolerance.” Under federal law, certain fees that you pay at closing must match, exactly or closely, the fees shown on your Loan Estimate.

Some fees may not change at all, including the origination fee, appraisal fee, tax service fee and HOA certification fee. Your lender should know what these fees are and should have no reason to change them at closing time.

Some fees can change by up to 10% at closing time, such as government recording fees. Other changing fees could also include services you can control, like termite inspection, homeowners insurance, commissions, and prepaid interest.

Come ready for closing day. Expect to sign lots of documents, including a contract to repay the money you’re borrowing, and a document giving the bank the right to take ownership of your property if you fail to pay.

You’ll also sign a closing disclosure. A copy of this document should arrive at least three business days before your closing date, giving you ample opportunity to compare the final closing costs to those specified on your loan estimate.

Read every document closely, both to understand what you’re signing and to ensure no mistakes were made.

During the closing process, you may encounter the lender’s representative, a closing agent, a notary public and your attorney (if you have one).

Most of your required documents will already have been submitted, but you may need to provide evidence of homeowners insurance and a cashier’s check to cover your closing costs, along with any prepaid interest and taxes.

If you refinance the loan on your primary residence with a new lender, you’ll have three days (not counting Sundays or holidays) after closing to change your mind and back out of the loan.

Once the waiting period ends, the escrow initiates the transfer of funds from your new lender and the payoff of your old loan. Interest on your new loan begins the day your new lender wires the funds to your escrow agent. Interest on your old loan continues to accrue until the old lender receives the payoff from the escrow agent. You will pay interest on both loans for at least one day, and possibly more.

Your refinance loan

When you’re ready to refinance your home loan, reach out to the team at Reali Loans for more information, or simply connect with us at 1.855.846.7334 and get your questions answered. Our qualified home loan advisors are standing by to provide you with an honest, straightforward experience so you are well-equipped to make the best refinancing decision for your financial goals.

 

 

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