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When you refinance a loan, you pay off your existing home loan and replace it with a new one, or combine a first and second mortgage into a single new loan. Refinancing is an excellent way to take advantage of lower rates, change the type of home loan you have, or access equity in your house.
Why Should You Refinance?
There are three primary reasons to refinance your mortgage.
Cash-out Refinance
If you have a substantial amount of equity in your home, you can refinance into a new, higher-balance loan to cash out your equity. This is a popular choice among homeowners who want to pay off debt or get together cash for a big purchase, such as a vehicle. A cash-out refinance usually has a higher interest rate than a straight refinance. Keep in mind that while your interest rate will be lower than a credit card interest rate, your payments will be spread out over 15 to 30 years, so you will likely pay more in the long run. Doing so will also turn unsecured debt into secured debt – with your home as collateral.
Reduce Your Rate
The most common reason to refinance is to take advantage of lower interest rates. There are closing costs with a refinancing loan, so it is usually best to refinance if the interest rate will be at least 1 percent lower. With a lower interest rate, your monthly payments will be lower.
Change Mortgage Type
You can also refinance your mortgage to get a new type of loan. For example, you may want to turn an adjustable-rate mortgage (ARM), interest-only loan, or balloon payment loan into a standard fixed-rate mortgage.
How to Refinance a Loan
You will need to go through the same process to refinance as when you got your original loan. This includes a credit check and employment and income verification. You will need to determine which type of loan you want before you apply, and choose a lender.
You do not need to refinance with the same lender as the original loan. You can turn to a mortgage broker to find the best refinancing rate. Once your application is processed, your home must be appraised. If your home's value has dropped, you may not be able to refinance your mortgage through conventional means.
Underwater Loan Refinancing
You do have options if you owe more on your mortgage than your home is worth. While most lenders require that you have at least 20 percent equity in your home, you may try the following options:
- Home Affordable Refinance Program (HARP)
- Home Affordable Modification Program (HAMP)
- FHA Streamline Refinance, if you have an FHA loan
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