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About Mortgage Refinancing

With interest rates at all-time lows in 2021, now is a great time to consider refinancing your mortgage. A mortgage refinance involves paying off your current loan and replacing it with a new mortgage. People refinance their mortgage loan to reduce their interest rate, shorten their loan term, and to consolidate debt.

Types of Mortgage Refinancing Products

Standard Refinance

A standard refinance follows the same rules as a standard mortgage, with a choice of conventional loan or a government-backed loan such as an FHA loan or VA loan. Basically, you pick the mortgage product that suits you and use it to take out a new loan, replacing your old loan. The maximum loan-to-value (LTV) on a standard refinance ranges from 80-97%, depending on the lender and loan type.

Cash-Out Refinance

A cash-out refinance is when the new mortgage is greater in value than what you owe on the old loan, allowing you to cash out the difference. A cash-out refi can be used for any purpose such as paying off credit cards, car loans, student loans, making home improvements, or putting money away for a rainy day.

No-Cost Refinance

Most refinances typically have closing costs, just like a regular mortgage. However, there is the option of not paying closing costs through what’s known as a no-cost refinance. The way it works is that the lender agrees to waive upfront closing costs in return for your commitment to spread the costs over the life of the loan. This is a great way to reduce your interest rate and generate instant savings on your monthly mortgage payment.

Streamline Refinance

A streamline refinance refers to the refinance of an existing FHA or VA loan. A streamline refinance reduces the time and costs to get a refinance. To qualify, your original mortgage must have been an FHA or VA loan, the mortgage must be current (not delinquent), and the refinance must result in a benefit to you (by law, the lender cannot put you in a worse position in regards to the interest rate or repayment term).

Types of Rates

Fixed-Rate Mortgages

Fixed-rate mortgages are the most common type in mortgage refinancing, and guarantee you a fixed rate for the duration of the loan. When you refinance with a fixed-rate loan, you’re getting a specific interest rate for the entire term of the loan. Given that interest rates have reached historic lows in 2021, the only direction that rates can realistically go from here is upward – which is why locking in a fixed-rate mortgage is currently a better option than betting on an adjustable rate.

Adjustable-Rate Mortgages

Adjustable-rate mortgages, also known as ARMs or variable-rate mortgages, carry higher risk and higher reward than fixed rates. An ARM is always cheaper than a fixed-rate mortgage in year one, but it carries the risk of higher interest rates during the later years of the loan. ARMs have two components: the number of years the initial rate gets locked in for; and the intervals at which rates get updated. Most lenders offer ARMs of 5/1, 7/1, or 10/1. A 5/1 ARM refers to an ARM with a fixed rate for the first five years and a rate update every year after that based on an index. The shorter your fixed period, the better your introductory rate. Because of their unpredictable nature, ARMs are best for borrowers with high risk appetite or borrowers who plan on selling the home or paying off the mortgage early.

How to Apply for a Mortgage Refinance

Whenever a lender refinances a mortgage, they take on a certain amount of risk because there is never a guarantee that the borrower will pay back the entire loan. The best protection for the lender is the property itself, which the lender foreclose upon if the borrower defaults on payments. The other way lenders protect themselves is by running a credit check on the borrower – similarly to as if they were applying to purchase a home.

The main things a lender will take into account are:

1. credit score
2. loan-to-value (LTV, the mortgage amount vs. the property value)
3. debt-to-income ratio (the monthly payment on your refinanced mortgage and other loans divided by your monthly qualifying income).

In order to process your application, the lender will ask for various documents including social security number, pay stubs and tax returns, and recent bank statements.

How To Shop Your Mortgage Refinance Options

LTV requirements

Loan-to-value (LTV) is as important a factor in refinancing as a down payment is when purchasing. The LTV ratio is a term used by lenders for the ratio of a loan to the value of an asset. If, for example, the loan you’re trying to obtain is 240,000 and your home is worth 300,000, your LTV is 80% (240,000/300,000).

APR

The monthly payments on a mortgage refinance have two components: principal, this amount goes towards your loan balance, and interest, as in the money the lender collects for providing the loan. Your APR, or annual percentage rate, is a mathematical calculation of the rate of interest plus the fees you’re paying for that interest rate. APR is not the holy grail when shopping for a mortgage as the loan product with the highest closing costs will almost always have the lowest rate and subsequent APR.

Terms

When you refinance a mortgage, you can start your repayment term over again with a 30-year term or you can go for a shorter term if you prefer. If your financial position is better than when you took out your original loan, then you can always look to shorten your loan term while reducing your interest rate.

Closing costs

Closing costs can vary drastically depending on the interest rate you select. Most lenders will advertise very low interest rates with very high fee structures. Your decision in regards to paying closing costs comes down to how long you plan to stay in the home. If you’re going to be there more than 5 years, you most likely want to spend the money on closing costs and get a lower interest rate. Closing costs vary from lender to lender, so knowing each lender’s approximate closing costs can assist you in doing a proper comparison.

Ease of application

Gone are the days when you had to walk into a physical branch to apply for a mortgage refinance. Today, the best mortgage lenders let you apply for a refinance online, the online process is supplemented by loan agents who will contact you to confirm the details entered into the system. If convenience is important to you, then keep an eye out for digital-friendly lenders.