Refinancing your Mortgage: A How-To Guide
@scottwebb
Is it time to refinance your home? To make sure this is a prudent decision for your family we want to share some considerations and outline the process.
WHAT IS A MORTGAGE REFINANCE?
A mortgage refinance replaces your current home loan mortgage with a new one. Homeowners will typically look to refinance when there has been a drop in interest rates. That said, a drop in interest rates is just one of many reasons someone would refinance their home.
Why is refinancing your home worth your time and focus? Because a mortgage is often one of the biggest expenses in a lifetime, it’s an important expenditure to get right. According to the US Bureau of Labor Statistics, Americans spend almost 32% of their income just on housing compared to the 0.71% spent on all nonalcoholic beverages (i.e. coffee). With regards to personal finance, it can be easy to blame our financial situation on the little things like the cost of your morning coffee. Rather than worrying about the little things like a cup of coffee, overextending ourselves financially with housing costs can hurt cash flow and diminish financial flexibility. A mortgage refinance can help adjust how much is spent on housing to provide a net positive impact on households both short term and long term.
MAKE A PLAN
Set clear financial goals regarding your mortgage refinance. Here are a few reasons why someone would consider refinancing their mortgage:
Lower Your Monthly Payment – Refinancing your home can reduce your monthly mortgage payment, providing more financial flexibility for years to come. There can be many advantages to extra money each month retirement savings, college savings, using monthly savings to pay more to the principal each month.
Reduce Your Loan Term – This may be an opportunity to shift from your 30-year mortgage to a 15-year mortgage. Reducing the term of your loan can be advantageous for those who would like to be debt-free sooner. A reduced mortgage term means you are likely to pay less interest over the term of the loan. Rates for 15-year mortgages are typically lower than those for 30-year mortgages.
Tap into Your Equity – Do you need to consolidate debt or take out equity for home improvement? Refinancing can free up your home equity for these needs.
DO YOUR HOMEWORK
It is important to “Know Before You Owe.” - Consumer Financial Protection Bureau (CFPB). The CFPB was established to protect and educate consumers in response to the Financial Crisis of 2007-08.
As you educate yourself, here are a few factors worth your consideration as you apply to refinance your mortgage:
Determine How Much Home Equity You Have - Refinancing a home can be more advantageous depending on how much equity you have. Your equity is determined by your home’s value in excess of the remaining balance of your mortgage. To assess your home’s value, utilize an online valuation tool or ask your real estate agent since they may have better tools and knowledge of your neighborhood. Additionally, a refinance can be a great opportunity to get out from under the monthly cost of PMI; to do this 20% of home equity is needed.
Know your Credit Score - Your credit score measures your creditworthiness to lenders. An ideal credit score is greater than 760, the higher the credit score the better rate you will qualify for. Similar to your initial home loan application, your credit score will be reviewed during the refinance process. Make sure that if you have previously frozen your credit that you unfreeze it by contacting all three credit bureaus, Experian, Trans Union, and Equifax. – To learn more about freezing your credit see our post on How to Prevent Identity Theft.
Understand your Debt to Income Ratio - Lenders use the following ratios to measure your ability to manage the monthly payments.
Monthly housing payments should not exceed 28% of gross income.
Monthly overall debt payments should not exceed 36% of gross income.
Shop Around - Shop around with multiple lenders to find the best refinance rates and request loan estimates for comparison. It helps to speak with several lenders on the same day as rates can/will change daily. Requesting a loan estimate will allow you to compare rates, total loan costs, and mortgage features. Be prepared to share the following documents with the lenders: Paystubs, W-2s last two years, Recent Bank Statements, List of debts and amounts, Current Mortgage Statement, Declaration page of homeowner’s insurance policy, Name and Phone of Insurance Agent, and Proof of other income. (Submit Loan applications, within a few weeks as not negatively impact your credit score.)
Understand your Break-Even Point – Once you know what types of rates are available to you, use a mortgage calculator to assess your break-even point. When deciding to refinance, it is important to know the point at which the cost of refinancing will be covered by your monthly savings. This break-even point will help decide whether the refinance process is worth it based on how long you expect to stay in your home.
Example: If your refinance costs you $3,000 and your saving $200/month over your new loan, it will take 1 year and 3 months to recoup your costs.
Will Your Taxes Be Impacted - Mortgage interest can be deducted on a tax return to help reduce income taxes owed. Since refinancing a mortgage often results in lower interest, your tax deduction may also be lower. This can also move a taxpayer from itemizing their taxes to taking the Standard Deduction. Consult your CPA or tax professional to discuss how refinancing could impact your tax situation.
MOVE FORWARD (DURATION: CAN TAKE UP TO 45 DAYS)
Decide on a Lender – Let your loan officer know of your intent to proceed with the mortgage application.
Lock-in Rate – Let your lender know that you would like to lock in your new mortgage rate. Rates will be locked for a fixed period, typically 30, 45, or 60 days. This protects you from rates increasing while you are waiting for the loan approval, processing, underwriting and loan closing.
Prepare for Appraisal (Duration: 2-3 weeks) – This can mean taking care of quick fixes, doing a deep clean and sprucing up the landscape. Spend your time and resources on things that NEED attention. Let the appraiser know if you have made any changes to the property.
Underwriting (Duration: 3 Days) – The mortgage company will verify that all information is correct. During this period you may receive additional questions or requests.
Review Closing Disclosure - At least three days before your closing you should receive a Closing Disclosure, which includes the details about your loan. Review and make sure this matches your loan estimate previously provided.
Prepare for Closing Costs – Be prepared to bring the full “Cash to Close” amount with you to your closing.
Sign and Close – This is the final step; go to the title and escrow office to sign all final loan documents for your refinance.
CONCLUSION
For many homeowners, a refinance can make sense at some point during their lifetime. When refinancing your mortgage it is important to set clear financial goals, do your homework and understand the process to help avoid pitfalls. We hope these considerations and outline can be a guide to you as you decipher whether a refinance is right for you. As always feel free to call or email at any time, let us know how Human Investing can help.
SOURCES:
https://www.consumerfinance.gov/know-before-you-owe/
https://www.myfico.com/loancenter/mortgage/step1/getthescores.aspx
https://www.bls.gov/cex/2018/standard/multiyr.pdf
https://www.zillow.com/mortgage-calculator/refinance-calculator/
