What Does It Mean To Refinance A House?

If you’re a homeowner, you’ve probably received more than your fair share of mortgage refinance offers. If you don’t live and breathe real estate, though, you might not be exactly sure what refinancing entails or why you might consider it.

So, what does refinancing mean? Let’s walk through the process and learn what it means to refinance a loan.

What Is Refinancing?

Refinancing a house is the process of replacing your mortgage with a new loan that has more favorable loan terms – like a new term length or a lower interest rate – or allows you to take money out for other important purchases and investments. A mortgage refinance can help you achieve a lower monthly payment, access the equity in your home and pay off your mortgage faster.

Refinancing can make sense if you’ve improved your credit score or debt-to-income ratio (DTI), or if interest rates have dropped since you accepted your original loan terms.

How Does Refinancing Work?

The loan refinancing process is very similar to the initial home loan process. To qualify for most refinances, you must be named on the ownership documents and own the home for 6 months or more.

Similar to your original mortgage, the higher your credit score, the better your rate will be. However, it’s possible to refinance with bad credit. Most lenders require a minimum credit score of 620 for conventional loan approval.

If you have a median FICO^® Score of 580 or better, you may be able to qualify for an FHA or VA loan with sufficiently low debt. In addition to an adequate credit score, you’ll need to build up enough equity in your home to qualify for a refinance.

20% Home Equity Or More

A general rule of thumb is that you should have at least 20% equity in your home if you want to refinance. If you want to get rid of private mortgage insurance (PMI), you’ll likely need 20% equity in your home. This is also the same amount of equity you need in your home to qualify for a cash-out refinance.

Under 20% Home Equity

If your equity is under 20% but you have a good credit rating, you may still be able to refinance. Your lender, however, may charge you a higher interest rate or have you take out mortgage insurance. Interest-reduction FHA refinance loans don’t have equity requirements, but you’ll need at least 20% equity for a cash-out refi.

Types Of Mortgage Refinances

While the reasons for refis are numerous, only four basic types of refinances exist. Let’s evaluate these options.

Cash-Out Refinance

A cash-out refinance is a handy way to convert your home’s equity into cash while refinancing your mortgage. A cash-out refi can help you fund projects or consolidate higher-interest debt, potentially saving you a lot of money.

Cash-out refinancing is great for borrowers with a lot of equity in their home if they want to use that equity to refinance for home improvements. Building an addition, adding a garage or outbuilding, or updating home systems can add value to your home and enrich your family’s life.

Rate-And-Term Refinance

A rate-and-term refinance lets homeowners change their loan’s mortgage rate, loan term or both. It’s likely your financial situation has changed and you may qualify for a lower rate, or your budget will allow you to pay your mortgage down more aggressively.

The goal of a rate-and-term refinance loan is to save money, which happens by getting a lower monthly payment or paying less interest because of a lower mortgage rate or a shorter loan term.

If you refinance to a shorter loan term, your monthly payments will be higher because you’re paying off the same amount of money in less time. However, you save money in the long run because you’re removing years of interest payments.

Cash-In Refinance

If you’ve come into a lump sum that you wish you’d had when you bought your home, you might want to consider a cash-in refinance, where you’ll get the chance to put your lump sum into a new down payment. If you’re refinancing to eliminate PMI premiums while getting a better interest rate, this is what you’ll want to explore.

On the other hand, if you’re already happy with your mortgage, you might consider a mortgage recast, sometimes called a mortgage reamortization. With a recast, you’re putting money into paying off your mortgage principal, which is reamortized to reflect the lower principal on which you’ll continue paying interest. But you keep your current mortgage rate.

Streamline Refinance

If you purchased your home with a mortgage offered through the Federal Housing Administration (FHA), the U.S. Department of Veterans Affairs (VA) or the U.S. Department of Agriculture (USDA), and if you’re looking for the benefits of a rate-and-term refinance without going through the full refinance process, consider a streamline refinance.

An FHA Streamline Refinance is available with very little paperwork, and it doesn’t require an appraisal. A VA Streamline Refinance, or VA IRRRL, is similarly easy to apply for thanks to fairly relaxed minimum requirements.

How To Refinance A Mortgage

Let’s say you decide to refinance your 30-year loan and take advantage of current mortgage rates. The first step is to reach out to your mortgage lender and a few others to compare pricing and discuss your options. Most lenders will require a simple online application for you to get approved for the mortgage refinance.

Mortgage underwriters will then evaluate the application in three areas: credit score, income and employment history, and assets and cash reserves. While the application is being considered, your lender will arrange a home appraisal by a licensed appraiser to determine the home’s market value.

Then, similar to the original mortgage process, you’ll close on your new home loan. The Closing Disclosure will outline the final terms of the loan, covering your new interest rate, closing costs, the amount of your monthly mortgage payments, and more.

Despite the similarities between a new mortgage and refinancing, borrowers can typically expect less paperwork when refinancing. Most refinances take less time to process than a new loan and can be clear to close in 30 days or less. If mortgage rates are low, expect a longer wait time to close, since many other homeowners may be refinancing at the same time.

How Refinancing Can Lower Your Monthly Mortgage Payments

Let’s look at an example to demonstrate how much it’s possible to lower your monthly mortgage payments and save in a refinance. (To see the impact refinancing can have on your own budget, you can also use our refinance calculator.)

Meet Alex, our prospective candidate for a refinance. They’ve purchased a home with a $200,000 30-year fixed-rate mortgage and an interest rate of 6.5%. The monthly payment is $1,264. After a year, Alex decides to take advantage of lower rates and refinance the home. They’re able to secure a mortgage loan with an interest rate of 5.1%, reducing their monthly payment to $1,068. This difference in monthly payment translates to $2,352 in savings per year.

Reasons To Refinance Your Mortgage

Refinancing can help homeowners achieve the following goals:

• Lower monthly mortgage payment amount
• Consolidate credit card debt
• Eliminate PMI
• Fund home improvements
• Lock in a lower interest rate
• Shorten the mortgage term length
• Convert from an adjustable-rate mortgage (ARM) with expiring initial rates to a fixed-rate mortgage, or vice versa

Pros And Cons Of Loan Refinancing

Before you decide whether to refinance your mortgage, take a careful look at your family’s budget. Base your decision on how much equity you have and what you plan to use the money for. Will it be worth it? Below are some pros and cons to help you decide.

Pros

• You could refinance to a lower rate with different loan terms, saving money each month and over the life of the loan.
• Taking cash out of your primary mortgage means you only worry about one monthly payment.
• Your mortgage interest may be tax-deductible.
• You can potentially take out a large lump sum to pay for home improvements or to pay off debt.

Cons

• You risk foreclosure on your home if you fail to make your monthly payments.
• You’ll pay closing costs on the entire loan amount.

A new mortgage will mean entirely new loan terms, which can be good or bad.

The Bottom Line: Mortgage Refinancing Can Help You Meet Your Financial Goals

Refinancing your mortgage may be a great option if interest rates are low and you want to reduce your monthly payments or pay off your mortgage sooner. Different refinancing options – like a cash-out refinance – can also help you turn your home equity into cash, which you can use to consolidate debt or make major home renovations.

Are you ready to make some changes to your mortgage? Apply to refinance today, and we’ll help walk you through the process and secure the mortgage refinance that works best for you.