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- When you refinance your home, you take out a new mortgage with a different interest rate and term length.
- Figure out what your financial goals are for refinancing, and check whether your finances are in good enough shape to start the process.
- Apply to refinance with multiple lenders so you can compare their interest rates and fees.
- Once you've chosen your lender and the terms of your new mortgage, you can schedule an appraisal before closing.
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What is refinancing?
You refinance a mortgage when you want to stay in the same home, but with different mortgage terms. By refinancing your mortgage, you take out a new home loan to replace your old one.
The refinanced mortgage will come with different terms. For example, you could switch from an adjustable rate to a fixed one, or from a 30-year loan to a 15-year loan. The new mortgage will also have a different interest rate.
Here are seven steps to refinancing your home:
Step 1: Decide what you want to get out of the refinancing process
There are many reasons to refinance a home, and determining a financial goal can help you navigate the process.
Do you want to pay off your home more quickly? If your original mortgage was a 30-year term and you have 25 years left, refinancing into a 15-year mortgage will help you pay off the loan 10 years sooner.
Do you want to take advantage of low interest rates? As long as you don't refinance into a longer term, refinancing to lock in a lower rate can save you money in the long run.
Do you want to make lower monthly payments? If you have 25 years left on your mortgage and refinance into a 30-year loan, then your remaining payments will spread out over a longer period of time, and you'll pay less monthly.
Think about why you want to refinance, and what would make the refinancing process worth your effort. For example, you might decide you want to refinance for a lower rate — but only if the interest rate is at least 1% lower than what you're paying now.
Step 2: Assess your financial situation
Just as when you took out your initial mortgage, you'll need a strong financial profile for refinancing to be worth your while. Take a look at your finances to figure out whether you can get a good deal now or should wait.
What's your credit score? If your credit score has remained steady or improved since you got your first mortgage, then you could get a good interest rate.
What's your debt-to-income ratio? For example, if your monthly debt payments have increased since your initial mortgage but your monthly income has stayed the same, then you might not get as a good of a deal as you'd like.
How much equity have you acquired in your home? Your home equity is the relationship between how much your house is worth and how much you still owe on your mortgage. If you owe $100,000 on your mortgage and your home is assessed to be worth $175,000, then you have $75,000 in equity.
It's important to know your equity percentage. An easy way to figure this out is to calculate your loan-to-value ratio, or how much you still owe versus how much your home is worth.
To calculate your LTV ratio, divide the amount owed (in this case, $100,000) by the home value ($175,000). You'll get 0.571, or 57.1%.
To find your equity percentage, subtract your LTV ratio from 100. When you subtract 57.1% from 100%, your total is 42.9%. You have 42.9% equity in your home.
Many lenders want you to have at least 20% equity, but you may be able to refinance with a lower percentage if you have a great credit score and low debt-to-income ratio.
Step 3: Shop for the best rates
Just because your current lender offered you the lowest interest rate on your initial mortgage doesn't necessarily mean it will give you the best deal the second time around.
Research lenders to find out who is offering the best rates right now. You can research companies through mortgage comparison websites, contact lenders directly, or use a mortgage broker as your middleman.
Step 4: Apply to refinance with multiple lenders
Apply for preapproval with several lenders to compare their offerings and find the best match.
Getting preapproval letters from multiple companies lets you compare interest rates side by side. If you ask for an itemized list of fees from each company, then you might discover a lender that charges a slightly higher rate will save you money in the short-term by charging less in closing fees. Then you can decide whether it fits your financial goals to go with the lower rate or lower fees.
Here are some documents you'll need to apply to refinance:
- Bank statements
- Tax returns
- Pay stubs
- Proof of assets
- Debt documentation
- Credit score
- Information about your current mortgage
When you apply for preapproval, a lender does a hard credit inquiry to find out your credit score; the inquiry will show up on your credit report and could temporarily affect your credit score. A bunch of hard inquiries on your report can hurt your credit score — unless it's for the sake of shopping for the best rate.
If you limit your rate shopping to a month or so, then credit bureaus will understand that you're looking for a mortgage and shouldn't hold each individual inquiry against you.
Step 5: Choose your lender and refinance terms
After comparing each lender's interest rates and fees, decide which one you want to use.
You'll need to land on either a fixed-rate or adjustable-rate mortgage, and choose a term length. For example, you may refinance into a longer term length to lower your monthly payments, or a shorter term length to pay off your home more quickly and save money in the long run.
Once you've chosen the lender and term, you can lock in your rate and move forward.
Step 6: Undergo an appraisal
Your lender might require a home appraisal when you refinance. You'll want to schedule the appraisal pretty soon after locking in your rate, because your rate only stays locked in for a certain amount of time, usually 60 or 90 days.
Not all types of mortgages require appraisals when you refinance. You might be able to get out of the appraisal if you have a government-backed loan, or if you're getting a conventional mortgage backed by government-sponsored mortgage companies Freddie Mac or Fannie Mae.
With these loans, there are conditions surrounding who can waive the appraisal. For example, Fannie Mae and Freddie Mac might still make you get an appraisal if you live in an area subject to natural disasters or refinance through a certain program.
Step 7: Close on your refinanced mortgage
You should close on the loan before your rate lock expires. This is when you'll pay the closing fees that you compared when you were choosing a lender. The closing process is pretty similar to how it was when you got your initial mortgage — except this time, you already live in the home.
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