Easy guide for refinancing a home

Refinancing a home is a big decision and can have significant implications on your monthly payment and years of outstanding debt. I’ve consulted with various sources to understand the pros and cons of refinancing to put together this easy guide for refinancing a home. Please note that the rates you pay and your qualification will depend on your unique situation. The tips below are a high level guide and may not apply to everyone.

What is Refinancing?

Let’s start off with defining the term, refinancing. Refinancing is the process of securing a new mortgage by changing the terms of your current mortgage. When you refinance your mortgage, your lender pays off the old one with the new one. The general rule of thumb states that you should consider refinancing if you can reduce your interest rate by at least 1-2 percentage points.

Why Do People Refinance?

There are a few reasons people choose to refinance.

Take advantage of lower interest rates: According to the Freddie Mac Primary Mortgage Summary, in 2020, mortgage interest rates have dropped on average from 3.6% to 2.8% on a 30-year mortgage. With COVID slowing the economy, these low interest rates have hovered around historical lows as the Federal Reserve seeks to fuel purchases.
Reduce the mortgage length: If your original mortgage terms are for 30+ years or more, refinancing is a great option to lock into a new fixed rate for a shorter period of time. However, be cautious; if your current interest rate is comparable to the refinance rate, don’t overwhelm yourself with a higher principal payment you can’t afford just to pay off your loan earlier.

Can anyone refinance?

The quick answer is no. In order to refinance your home, you must meet certain qualifications so you must provide proof of the following.

Original Mortgage Payments: Lenders want to make sure that you’ve been consistently paying your mortgage on time over the last 12 months (although this may vary on the type of loan you secured).
Equity: You must own 10-20% equity in the home.
Credit score: Lenders will look at this to determine your trustworthiness in paying off debt. Typically, anything north of 600 is acceptable.
Debt to Income Ratio (DTI): Your DTI is calculated by dividing your monthly debt payment by your gross monthly income. The monthly debt can include anything from car payments, credit cards, mortgages, etc. Most lenders will prefer that this DTI sit at no more than 50%.

Qualifications may vary so be sure to consult your lender before proceeding. Here is a link to the Bank of America refinancing site with rate examples to help guide you.

EASY GUIDE FOR MANAGING A HOME TIP: Before refinancing, manage your expenses carefully-try not to accumulate additional debt as this may impact your qualifications.

I qualify. What do I need to get started?

A huge part of the easy guide to refinancing a home is being prepared. Come ready with these items when you meet with a loan manager. This process can sometimes be time consuming so the more you prepare ahead, the smoother the process.

Proof of Income: Similarly, to when you first applied for the loan, you must provide a steady proof of income including your latest W-2s and tax returns, 2-3 months of pay stubs, bank account statements, etc.
Proof of assets and liabilities: The lender will typically ask you to bring in statements associated with your checking account, 401k, IRA, or any other asset you hold. On the flip side, the lender will also ask for proof of debt which may include official documentation from other loan providers confirming your monthly payment.
Proof of Homeowner Insurance to verify that you have enough insurance to cover the home.
A recent credit report
Home Appraisal
Check for the application fee

How much will this costs me?

Refinancing will cost you money upfront, typically in the range of 2-6% of the loan amount. Below are some fees you’ll likely encounter in the process:

Loan application fee
Loan origination fee
Home appraisal
Credit report fee
Title search
Mortgage points
Settlement fee

Before agreeing to refinance, make sure you can a) afford the closing costs and b) have conducted a break-even analysis to understand how long it will take to recuperate these fees.

For example, let’s say three years ago you took out a 30 year fixed-rate mortgage for $300k at a 4% loan and now want to refinance to a 15 year loan at 2.5%. With these terms, your monthly payment will increase from $1,432 to $1,894, costing you an additional $461 a month but saving $41,899 in the remaining life of the mortgage. Earlier we estimated closing costs to be within 2-6% of the loan. For this case, we will use 3.5%, bringing the total closing fees to about $8,500. With the refinanced rate of 2.5%, we are saving 1.5% of interest every year on our loan or $4,500). Therefore, it will take almost two years to breakeven on the closing costs. However, after those two years we can enjoy the benefits of the lower interest rate.