When refinancing, you use money from a new loan to pay off an existing loan. You will have to go through a loan-approval process again. But for many homeowners, this process is worthwhile. Let’s take a look at when refinancing your mortgage makes sense, how to prepare yourself for it, and what steps you’ll need to take.
When To Refinance Your Mortgage
There are plenty of times when it can make sense to refinance your mortgage. You may want to take advantage of lower interest rates than your current mortgage has to save money. You may also want to withdraw equity from your home, which would provide you with cash to use for, say, home renovations or your child’s college expenses. Refinancing also allows you to adjust the terms of your mortgage. For example, you may want to change a 30-year mortgage into a 15-year mortgage, or vice versa. Or you may want to replace an adjustable-rate mortgage (ARM) with one that has a fixed rate. You can calculate your break-even point to help you determine how long it will take to recoup the costs of refinancing and whether that will be worthwhile to you.
Preparing To Refinance
If you’ve decided that refinancing would be a good option for you, prepare for the process to ensure that it goes smoothly. Here are a few steps you’ll want to consider taking: First, determine what type of refinance you will need. If you simply want to adjust the interest rate or the term (or both), you will need a rate and term refinance, also known as a traditional or regular refinance. If you want to tap your equity for cash that you can use for other reasons, choose a cash-out refinance. Second, make sure you understand your finances. Banks have strict requirements when it comes to mortgages, and refinances are no exception. Knowing your credit score and your debt-to-income ratio can help you understand what you may qualify for before you apply. You can get a free annual credit report at AnnualCreditReport.com. Finally, consider shopping around for mortgage rates. Interest rates can vary from bank to bank, so it’s always a good idea to compare multiple options and determine which one fits your financial situation the best.
How To Refinance Your Mortgage
Once you are ready to move forward, you should be familiar with some common steps for the refinancing process that homeowners take.
Gather Your Documents
A refinance will require plenty of documentation. This will include bank statements, pay stubs, and tax returns, among any other financial documents the bank asks for. Having these on hand can help the process go forward more smoothly and quickly.
Contact Your Lender
After shopping around, you’ll want to contact the lender with whom you want to refinance. They can guide you on their specific requirements for completing their application. Make sure you read all the terms and conditions of their contract so you understand their particular fees.
Lock In Your Interest Rate
Most mortgage lenders will allow you to lock in your interest rate for your new loan. Interest rates move up and down with the market. The amount of time during which lenders will let you lock in your rate can vary, but it will typically range from 30 to 60 days. Some lenders may allow you to lock the rate for up to 120 days.
Avoid Opening New Credit
Try to avoid applying for any new credit—like a personal loan, car loan, or credit card—when you’re refinancing. Importantly, this can affect your credit score or alter your debt-to-income ratio, which can affect whether you qualify for a refinance. Lenders will check your credit score both when you apply and before closing, so they’ll see if anything has changed. Adding new credit can indicate to lenders that you’re struggling to meet your financial obligations. This can, in turn, lead them to lose confidence in your ability to repay.
Prepare To Close
Once you’ve been approved for a refinance, it’s time to prepare for closing. Some lenders may allow you to roll the closing costs of refinancing into your new loan. Otherwise, you’ll need to have cash on hand to fund the close. After the refinance closes, your new loan will pay off your old mortgage and take its place.
