If you have a mortgage, you don't necessarily have to make payments on the same loan for 15 or 30 years -- you could refinance your loan somewhere along the way. However, refinancing isn't well understood by many U.S. homeowners, so here's a look at how refinancing a mortgage works and how to refinance a mortgage if you think it might be a good move for you.
In the financial world, the term refinancing means using a new loan to replace an existing one. So, refinancing a mortgage means obtaining a brand-new mortgage to replace your current one.
There are several reasons people refinance their mortgages, which we'll get into in detail later. But for the time being, know that refinances are generally done to improve the terms on your mortgage, to save money on interest by getting a lower mortgage rate, to cash out some of your home equity, or a combination of the three.
The process of refinancing a mortgage works in a similar way to obtaining a mortgage to purchase a home, with the obvious difference being that you already own the home. You'll need to contact a lender, fill out a mortgage application for a refinancing loan, and go through the lender's approval process.
There are two main qualification requirements for refinancing your mortgage. First, your personal credit and income qualifications must be sufficient to justify the mortgage. Borrowers with top-notch credit scores tend to get the best interest rates on refinancing loans, just as they would with a purchase mortgage. Lenders also want to see that the borrower's income is sufficient to comfortably handle the loan payments, and that they have a stable employment situation, which typically means at least two years of steady work in the same field. Most lenders also verify a borrower's assets. It's common for them to look for a certain number of monthly payments in readily available reserves.
As for the second requirement: Your home's value and the amount you want to borrow must make good financial sense to the lender. In most (but not all) cases, lenders want to see that the new loan will produce a maximum loan-to-value, or LTV, ratio of 80%. For example, if your home's appraised value is $200,000, most lenders will refinance a maximum of $160,000.
There are some exceptions, however. Refinancing loans with an LTV of as high as 90% or even higher aren't uncommon, but the borrower will typically need to have top-notch qualifications in order to obtain a refinancing loan like this.
Finally, it's important to point out that refinancing a mortgage is not free. Refinancing loans typically involve closing expenses, such as underwriting and origination fees, just as there would be with a purchase mortgage. Some of our favorite mortgage lenders for refinancing have below-average fees, but refinancing is still likely to cost you something.
There are several types of refinancing loans, but most fall into these broad categories:
There are a few reasons it might be a good time to refinance your mortgage, and here are seven of the most common:
The short answer is that you can refinance your mortgage as soon as you want. If you obtained a 30-year mortgage at 5% interest and rates plummet to under 4% within a couple of months, it could certainly be a great idea to refinance your loan.
Having said that, some lenders might have restrictions. It's not uncommon for lenders to require a six-month period to pass before obtaining another mortgage on the property with the same lender. However, you can still shop around and see if you can refinance through another lender if doing so would be a smart financial move.
As mentioned, mortgage refinancing is based on two main factors -- your personal credit qualifications and your home's value. Your lender will typically take care of the latter by ordering an appraisal.
However, you'll likely need to provide some documentation during the process. This can include, but is not necessarily limited to:
To sum it up, here's the process of refinancing your mortgage:
Yes. It's not uncommon for homeowners to refinance their mortgages several times, even in a relatively short time frame. For example, if you buy a home and mortgage rates drop sharply, you could refinance to get a lower interest rate. If you want to tap into your equity to renovate your kitchen a few years later, you could refinance again. Some lenders have restrictions when it comes to the frequency of refinancing, but you can always try with another lender if this becomes an obstacle.
Refinancing will certainly impact your credit score, but not in the way you might think. Initially, the presence of a new loan on your credit report could be a negative. However, as time goes on and you make your loan payments in a timely manner, refinancing can help boost your credit score.
Absolutely. A refinancing application can be denied because of issues with the borrower's personal qualifications, or because the home's value doesn't justify the amount of money requested.
Yes, you can refinance with the same lender from which you obtained your original mortgage. However, many lenders have minimum time requirements between mortgages. Six months seems to be the most common period before you can refinance with the same lender.
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