The refinancing of your home is the replacement of your existing home loan with a new loan. The most common reason to refinance is to take advantage of a significant drop in interest rates that has taken place since the original mortgage was taken out. You also may want to refinance to draw cash from the equity in your home, often for the purpose of making home improvements. The refinancing process consists of a number of steps that you’ll need to carefully complete to maximize benefits.
1. Set your goals
The first step in refinancing is to determine why you want to do it, as this answer will guide the rest of the process. Saving money in the long term is generally the most sensible reason for refinancing. Your new loan should typically reduce your interest rate by at least one percentage point to pay for the administrative cost of processing the new loan. If your original mortgage has an adjustable interest rate, you also might decide to refinance to obtain the financial stability afforded by a fixed-rate loan with fixed house payments.
Lowering your interest rate often will have the related benefit of reducing your monthly payment, another common goal of refinancing. You can also refinance to reduce the term of your loan if you can afford the higher monthly payments. Shortening the term of your loan will reduce the total interest you pay.
You can also use a cash-out refinance like the one available from Figure. This option involves taking out a new loan for more than the balance on your current loan and getting the difference in cash. This option may make sense when you need to pay for a major unavoidable expense like essential home repairs.
Getting rid of your mortgage insurance premium (MIP) on an FHA loan is another reason to refinance. By refinancing your FHA loan through a private lender, you can take advantage of a provision that allows you to cancel mortgage insurance on a private loan once your equity exceeds a certain minimum, usually 20%.
2. Check your credit history
A higher credit score will allow you to get a lower interest rate on your refinance, so you need to ensure that your score is as high as possible. Correcting reporting errors is one of the easiest ways to quickly improve your credit score. You also can do so by paying down your existing debt, although this approach will expend money that you may need to close on your refinance.
The biggest factor in your credit score is consistent bill payment over time. It’s also important to avoid using more than 30% of your available credit line. Even if you’ve paid off credit accounts, resist the urge to close them because that would reduce both your available credit and your credit score. Additional factors that affect your credit score include your total debt, the length of your credit history and new applications for credit.
3. Calculate your equity
You need to calculate the value of your equity when considering a refinance, since it’s a major factor in determining how much you’ll be able to borrow. Equity is the portion of your house’s value that you actually own and is commonly expressed as a percentage. Assume for this example that your house is worth $300K on the open market and that the balance on your mortgage is $240K. Your equity is $60K ($300K - $240K), which is equivalent to 20% (($60K / $300K) x 100) of the value of your house.
4. Shop for lenders
Interest rate is the factor that most borrowers consider most closely when looking for a lender, but you should look at other factors as well. For example, lenders charge various closing costs on the new loan. Some lenders require that closing costs be paid upfront, while others will roll the costs over into the new loan balance. Some lenders offer “no-closing cost loans,” but they compensate by charging a higher interest rate. Make sure you’re looking at the total cost over the full term of the loan when selecting a lender.
5. Disclose your finances
Lenders will need to review various financial statements before approving your loan. These will primarily include proof-of-income statements such as pay stubs, but lenders also may ask to see tax returns and bank statements. Some lenders like Figure offer an online application that automates the process of gathering and verifying financial documents.
6. Wait for the appraisal
For the borrower eager for a refinance approval, waiting for an appraisal to be completed can seem to take forever. Lenders need to calculate the value of your home to determine the percentage of your equity. Some lenders will perform a drive-by appraisal to verify the general condition of your home, while others will require a formal appraisal by a professional appraiser. Be sure to inform your lender of any improvements or repairs you’ve made to your home that could increase its value.
7. Close on the refinance
The time needed to close on a refinance varies considerably among lenders. Some lenders take as long as 39 days on average to close, but Figure’s at-home closing process can close much faster than other options. If you’re required to pay the closing costs out of pocket, be sure you’re prepared to do so. It may be possible to roll these costs into the loan, but this will increase your loan amount and probably the term of your loan and your monthly payment. It also may increase your interest rate.
8. Watch your loan
Once you close on your new loan, you’ll typically be able to automate your new monthly payments, and some lenders even offer a discount for doing so. Be advised that lenders may sell your loan to another lender on the secondary market. If this occurs, you will be making payments to a different company with different rules about payments. Look for notifications from your lender and read them carefully to ensure that you don’t miss such a change, particularly if your payments are made automatically.