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How Does A Home Refinance Work, And When Should You Do It?

Erica Gellerman5-Minute Read
December 18, 2020

You’re seeing interest rates drop and you’ve heard people talking about qualifying for a home refinance. But what is home refinancing and is it a good idea for you? This article will walk you through everything you need to know.

What Is Home Refinancing?

A home refinance swaps out your current mortgage for a different one, usually with a lower interest rate. Other benefits of refinancing include lower monthly payments, new loan terms or getting a new type of loan altogether.

How Does Refinancing Work?

When you first purchased a home, you borrowed money from a lender to pay the home seller. Now you’re making monthly loan payments to that lender to pay back the money that you borrowed.

When you refinance, you take out a new loan. That new loan pays off the old loan and you’re left making payments on the new loan.

Do I Qualify For A Mortgage Refinance?

If you’re hoping to qualify for a home mortgage, there are a few things you’ll need to have in place. A lender wants to ensure that you have the ability to repay the loan, so they’ll look at:

  • Your credit score: it doesn’t need to be perfect, but you’ll need to have a decent credit score to qualify for a mortgage refinance.
  • Your income: this helps a lender understand your ability to repay the loan. If you have sufficient income, a lender will feel more comfortable that you will be able to make your monthly payments.
  • Your equity: the equity in your home is the difference between your home’s value and how much you own on the home. A lender wants to make sure that you’ve built up enough equity in your home.

How To Refinance A Mortgage

Think you might qualify for refinancing? Here are some steps you can take next.

1. Talk To A Lender

If you’re interested in refinancing, your first step is to start talking with a lender to understand what refinancing options they offer. They can help you determine whether you qualify for their refinancing.

Get started by talking to a home loan expert at Rocket Mortgage. They can help you assess your current situation and find the loan option that’s right for you.

2. Apply To Refinance

Once you decide to refinance, you’ll need to apply with your chosen lender. There are a number of items your lender may look at, including your:

  • Income
  • Current debt
  • Credit score
  • Total assets
  • Recent pay stubs, W-2s and bank statements

3. Lock In A New Interest Rate

Once your lender has prequalified you for a refinance, they’ll give you the loan terms, including the new interest rate. Once you agree to the terms, your loan rate should be locked. That means that the interest rate quoted won’t change between when you accept the terms and when you close on the refinance.

4. Underwriting

Once you’ve submitted your documents, the loan heads to the underwriter. During this process they’ll verify all of the documents that you’ve provided (and they may ask additional questions) and make sure they have everything they need to approve your new loan.

5. Appraisal

If an appraisal of your home is needed during the refinancing process, this is when that will happen. During the appraisal process an appraiser will come to your home and determine how much it is worth. This is important to the lender because they don’t want to lend you more money than your home is worth, or more than their loan-to-value (LTV) requirements. The appraisal value will help them determine how much they can lend you with a loan refinancing.

6. Close On The New Mortgage

Once all documents have been approved, you’ll close on your new mortgage. There will be closing costs, but all closing costs will be outlined and provided to you ahead as part of the Closing Disclosure.

7. Start Making New Payments

Now that your new loan is ready, it’s time to start making payments! For ease, consider setting up auto payments so you never miss a due date.

When Should I Refinance My Home?

There are a number of reasons why refinancing your home mortgage could make sense. These include:

  • Reduce your monthly payments: Your monthly payment will decrease if you refinance to a loan that lowers your interest rate or increases the number of years you have to pay off your mortgage.
  • Lower your interest rate: With interest rates currently so low, refinancing can help you lock in a lower interest rate so you pay less money in interest.
  • Adjust your loan terms and pay it off faster: Want to switch from a 30-year mortgage to a 15-year mortgage? When you refinance you can change the length of your loan.
  • Eliminate your private mortgage insurance (PMI) if you have it: If your home has increased significantly in value, refinancing and getting a new home appraisal might help you get rid of your PMI.
  • Switch from an adjustable rate mortgage (ARM) to a fixed-rate one: Your current interest rate may be a variable rate, meaning it increases or decreases – it doesn’t remain the same over the whole loan period. With interest rates so low you may want to lock in a low interest rate with a fixed-rate mortgage.
  • Take cash out: A cash out refinance allows you to utilize your equity and have money on hand to do things like consolidate your debt or complete some home renovations.

FAQs About Home Refinancing

Still have questions about home refinancing? We have answers.

What Is The Average Cost To Refinance?

Refinancing isn’t free – there are going to be costs associated with it. Your lender will charge you closing costs, just like when you bought the home. Those costs might include an application fee, an appraisal fee, a title search fee, and any attorney fees.

Can I Still Refinance Without The Proper Qualifications?

If you don’t think you have the ability to qualify for a mortgage refinancing on your how, there are still other options. Adding a co-signer to your mortgage can help you qualify, especially if their income and credit score are strong. But your co-signer will be legally responsible for the loan if you’re unable to repay, so it’s important that they understand their responsibilities.

What Is A Cash-Out Refinance?

If you’ve built up significant equity in your home, you might be interested in doing a cash-out refinance. With a cash-out refinance, you pull some of the equity out of your home. For example, say you have a home that’s worth $300,000 and a mortgage of $150,000. You want to access some of the cash, or equity, that you’ve built in your home. With a cash out refinance you can take out a bigger mortgage (let’s say $225,000) and get a check from your lender for the difference. In this case, you’d get $75,000 with a cash out refinance.

Just remember that a cash out refinance will increase your mortgage, so you could end up paying more in interest over the life of your loan.

Can I Refinance An FHA, VA Or USDA Loan?

Loans through a government program like FHA, VA, or USDA can be refinanced. VA loans offer an interest rate reduction refinance loan (IRRRL), which is a streamline refinancing option.

FHA loans also offer streamline refinance options to homeowners who have current, FHA insured home loans. And the USDA home loan program also offers streamlined assist refinance loans.

Bottom Line

Refinancing your mortgage can be a great way to save money and get loan terms that are better than what you currently have. While refinancing can cost money in the short term, in the long run you may be able to save significantly by refinancing your mortgage to a lower rate.

If you’d like to learn more about refinancing, lending, and owning a home, learn more at the Rocket HomesSM Homeowner Guide.

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    Erica Gellerman

    Erica Gellerman is a CPA, MBA, personal finance writer, and founder of The Worth Project. Her work has been featured on Forbes, Money, Business Insider, The Everygirl, The Everymom and more.