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Refinancing is easier than you think

Refinancing is the process of paying off your existing mortgage with a new mortgage. Knowing how to refinance mortgage loans is a crucial financial skill that can make your home more affordable from month-to-month and save you money over the life of the loan.

Typically, you refinance your mortgage to reduce your interest rate and monthly payment, or to change the length (or term) of your mortgage. You may also refinance to take cash out of your home’s equity.

What is mortgage refinance?

Refinancing is the process of paying off your existing mortgage with a new mortgage. Typically, you refinance your mortgage to reduce your interest rate and monthly payment or change the length (or term) of your mortgage. You may also refinance to take cash out from your home’s equity.

9 Steps to refinancing

This guide covers the topic of how to refinance a mortgage in nine simple steps. There are many reasons for refinancing a mortgage — the most common being interest rate reduction, lowering payments, converting adjustable loans to fixed loans, cashing out home equity, payoff acceleration and dropping mortgage insurance coverage. The first step, then, is determining whether refinancing a home will help the consumer achieve his or her goal.

Step One: Goal Determination

Refinancing can involve some compromise — obtaining the lowest rate means paying higher fees, for example. Lowering the payment can involve stretching out the remaining balance over a longer term, which could mean higher interest expense over the life of the loan. Accelerating the mortgage payoff means accepting higher monthly payments. The first step, then, is determining the goal of the refinance and if it can be achieved under current market conditions. For example, if a homeowner wishes to obtain a lower rate, he or she can compare the current rate to real-time rates from competing lenders with LendingTree’s LoanExplorer tool.

Step Two: Learn Your Current Credit Score

Once you decide that market conditions make refinancing attractive, you should check your credit score. Do this even before you start talking to specific lenders, because if there are issues with your score that need to be addressed, you will need some time to take care of that.

Your credit score can impact refinancing in a few ways. A low credit score can prevent you from being approved for a new loan. Even if your score is not so low as to get you turned down, having relatively weak credit can increase the cost of refinancing by causing you to have to pay mortgage insurance, or by prompting lenders to charge you a higher interest rate.

Your credit score indicates to lenders how risky it is to lend you money, and the more risk a lender takes, the more that lender will charge you to compensate for that risk. Checking your credit score can allow you to identify problems that can be readily fixed. Clearing up any mistakes in your credit history, or catching up on any payments you may have inadvertently missed, can allow you to improve your credit score before you apply for refinancing. That improvement in credit score can lower your costs, or even make the difference between approval and rejection.

Step Three: Research Your Home’s Current Value

A big factor in refinancing is how much equity you have in your home. Equity is the difference between the current value of the property and how much you still owe on your mortgage. The bigger the equity cushion, the better your refinancing options are likely to be. If you have 20 percent or more of the home’s value in equity, you should be in excellent shape for refinancing. If you have a bit less equity than that, you may find refinancing more expensive. If you have little or no equity, you are likely to find your refinancing options extremely limited.

Since real estate values change all the time, you need to make an up-to-date estimate of your home’s value. Check out real estate websites for estimates of your property’s market value and also look at the recent sale prices of comparable properties nearby.

Step Four: Use a Mortgage Refinance Calculator

A refinance calculator is an excellent tool for comparing your current loan with possible refinance opportunities. The two key things to look at when making this comparison is how refinancing would affect your monthly payment and how it would change the total cost of the loan in the long run.

Often, the size of your monthly payment is the most obvious thing people look at when refinancing, and being able to afford those payments is essential. However, spreading a mortgage out over a longer period can lower your monthly payments at the expense of costing you more interest over the long run. A mortgage refinance calculator can help highlight trade-offs like this, as well as show you how any long-term savings from refinancing might compare with your closing costs.

Step Five: Lender Selection

There are several ways to find mortgage lenders, but the most efficient method is by obtaining quotes online. This allows the borrower to request and receive information quickly. That’s vital because mortgage rates change continually as financial markets move. Quotes received hours apart may not be useful if bond prices are changing quickly. The homeowner should check pricing and then interview several lenders with competitive rates.

Step Six: Program Choice

Most refinancing goals can be met with more than one program, and a knowledgable loan professional can help borrowers winnow out the most appropriate program for their needs. For example, homeowners desiring smaller payments can achieve them by finding a lower interest rate, stretching out their remaining balance over a longer term or choosing an interest-only loan. The loan officer should assess the borrower’s risk aversion, expected tenure in the home, and plans like retirement or starting a family.

Step Seven: Know Fees and Additional Costs

While mortgage rate comparisons tend to be the focal point of shopping for a refinance loan, it is important to take a careful look at other fees and costs. These can represent a significant amount of money, and might even make the difference in determining whether or not refinancing is cost-effective. These comparisons are complicated by the fact that lenders have a variety of ways of distributing the cost of refinancing between interest rates and fees.

Get a complete, written list of projected costs from your lender before committing. Some of the things you should be looking for include fees for things like the application, appraisal and inspection, loan initiation points, mortgage insurance premiums, and various legal and administrative fees. You should also check your existing mortgage to see if refinancing would trigger any sort of prepayment penalty.

These fees and costs generally add up to a significant amount, so they should not be overlooked as part of your refinancing decision. Also, don’t be fooled by so-called “no-cost” refinancing programs. These generally involve adding the upfront costs to the amount you are borrowing. That might mean less expense on the front end, but it is likely to cost you more in the long run because you will be paying interest on those costs.

Step Eight: Refinance Application

Refinancing a mortgage involves a mortgage application. Today, most loan officers or processors interview applicants and complete the forms for them. Applicants should provide statements from bank and investment accounts, their most recent two pay stubs and W-2s (for salaried employees) or tax returns (for income from commissions, self-employment or investments). A mortgage underwriter (human or automatic) may request additional documents like divorce decrees, business licenses or letters explaining credit issues. Credit reports are pulled and unless the refinance is a streamline product, the property is appraised. The efficiency of the lender and experience of the loan officer are crucial, so borrowers should interview lenders and check their reputations. LendingTree provides ratings and reviews of lender partners to help customers find the right company for the job.

Step Nine: Lock and Close

The final step is locking in a mortgage refinance rate and closing the loan. Locking a rate can be done at any time during the refinance process. Until the interest rate is locked, borrowers are said to be “floating” their mortgages. Once a rate is locked, it is guaranteed until the lock expires — unless there are “material” changes to the application, such as the borrower choosing a different program or the home appraising for less than expected. Borrowers who are floating their mortgages can check current mortgage rates before deciding to lock or continue floating. At closing, the final costs of the refinance are reconciled to the costs disclosed when the loan was locked. The actual costs cannot exceed the disclosed costs by more than allowed by law or the lender has to absorb the excess.

Closing a refinance differs from closing a purchase. If refinancing a primary residence, there is a three business day rescission period after the borrower signs the final documents. This is a cooling off period in which the borrower can back out of the refinance for any reason. Once that period expires, the refinance loan is funded and the old loan is paid off.

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