You’ve probably discovered by now that the only constant in life is CHANGE. Fortunately, once you own your home, your mortgage can change along with your needs and your situation. But how can you be sure you’re making the right decisions? 

Armed with plenty of knowledge, you’ll be able to make the most out of your refinance, and avoid some common pitfalls. Let’s get started!

What is home refinancing? 

A refinance occurs when you acquire a new mortgage to take the place of your current loan. The new mortgage loan will have different details, such as a shorter or longer repayment period, a new mortgage rate, or an adjusted payment and loan amount.

Why do homeowners choose to refinance? 

Here are the most common reasons to refinance:

• Lower your interest rate: A reduced interest rate, even just one percentage point, can save you thousands of dollars over the life of your loan.  
• Shorten your repayment period: With a reduced interest rate, it’s possible to switch to a shorter loan term—for example, from a 30-year mortgage to a 15-year mortgage—and maintain a similar monthly payment.
• Access equity: You may wish to cash out on their mortgage for purposes like home improvement, paying off debts, or funding your child’s college tuition. There are some risks associated with this kind of refinance, which we’ll discuss below.
•  Change loan type: Homeowners may use a finance to switch from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage (or vice-versa). If interest rates are expected to decline before you sell your home, an ARM makes sense. If interest rates are expected to rise, a fixed-rate mortgage is probably in your best interest.

What is refinancing going to cost?  

Before you move forward with a refinance, it’s important to have a solid understanding of the costs associated with replacing your loan. Here’s what to look for: 

• Origination Fees: An origination fee, usually .5% to 1% of the loan amount, is charged by your lender to cover the expenses incurred by processing your loan. This charge can also be called an administration fee, an underwriting fee, or a document processing fee.
• Title Insurance: When you refinance your home, your previous title insurance coverage expires. Title insurance protects you financially from errors in your paperwork or property records. Your lender will ensure that a new policy is in place, at a fee that usually ranges from $1000-$3000. 
• Mortgage Insurance: If you carried private mortgage insurance (PMI) prior to your refinance, there’s a chance it will still be required along with your new loan. The cost of PMI depends on your loan amount, equity, and risk level.
• Appraisal and Inspection: These services ensure, for the security of the borrower AND the lender, that your house is valued accurately. Although you most likely had an appraisal and inspection performed to secure your original loan, you’ll need to have them performed again in order to refinance. Together, these services will add several hundred dollars to your cost to refinance.

Reasons NOT to Refinance

Sometimes, replacing your mortgage is not the best move. You might want to rethink that refinance in the following situations: 

• Your payment goes down, but your loan is extended: While a lower payment could free up some cash month to month, you will end up paying thousands more in interest over the length of the repayment period.
• You may be moving soon: No one can predict the future, but use your best judgment to determine if you’ll sell your home before reaching the breakeven point.

The breakeven point is the amount of time it will take to recoup your refinance fees. Use a breakeven point calculator to determine how long you need to make payments on your new loan to make up for the costs of refinancing.

• You’re changing your loan type at the wrong time: Switching from an ARM to a fixed-rate mortgage doesn’t make sense when interest rates are declining or if you’ll be moving before your loan is likely to reset at a higher rate.
• You’re hopping on the “debt treadmill”: Refinancing to withdraw equity is a slippery slope. For example, when a borrower refinances and withdraws cash to pay other debts, it is not uncommon for debts to stack right back up again. This leaves the borrower with less equity in their home, AND more debt.

Common Types of Refinance Loans

Refinance loans vary depending on the borrower’s situation and goals. Here are the most common types: 

• Rate-and-Term: The borrower’s original loan is replaced with a new mortgage with lower interest, usually after a dip in market interest rates. This allows the borrower to lower their payments or shorten the length of their repayment period.
• Cash-Out: Withdrawing equity in exchange for an increased loan amount. This type of refinance usually results in a higher interest rate.
• Consolidation: Rolling higher interest debts into a new mortgage loan. For example, borrowers may be able to combine their student loan amount into a mortgage loan. Although it makes sense on paper to move debt to a lower interest loan, it can be risky to shift more flexible, unsecured debt to a loan that is backed by a very important asset (your home).

What Happens During the Refinance Process?

If you’re considering a refinance, here’s how to get started and what to expect:

• Understand your goal: What is your reason for refinancing? Make sure you’re clear on your motivation, such as lowering your payment amount, paying your home off sooner, reducing your interest rate, etc. 

• Use a refinance calculator: Punch in some numbers and analyze the results. You may be surprised at how much money the refinance will save you...or how much it will cost.

• Shop for the best rates: Visit at least three lenders to select the most beneficial refinance offer. Each lender will provide you with a loan estimate that includes details like terms, payment amounts, and fees so you can compare them side-by-side.

• Choose a lender: Select the offer that best helps you meet your refinance goal.

• Lock in your rate: A mortgage rate lock guarantees the offered interest rate from initial loan approval through loan closing. 
• Close: Meet with your lender to sign documents and disclosures.

A mortgage refinance is an impactful event that can significantly alter the course of your financial future. If you have any questions or concerns, it’s a great idea to check in with a trusted financial advisor. Best of luck as you move forward as a homeowner!