By T.J. Porter, WCI Contributor
If you own a home, you probably have a mortgage. Few people, even those physicians with high incomes, can afford to pay for a house out of pocket, so lenders offer long-term loans to make buying property affordable.
You’ve likely heard people talking about refinancing their mortgages, which lets them adjust the terms of their loan. Refinancing can be a good idea in a few different situations. Here's what you should know about how and when to refinance your mortgage.
What Does It Mean to Refinance a House?
Refinancing your house means replacing your existing mortgage with a new mortgage that has new terms. In short, you apply for a new mortgage and use the money from that loan to pay off your old one.
You can refinance your home for a few different reasons. One reason is to switch your loan to a new lender. People also commonly refinance to lower the interest rate of their loan, reduce their monthly payments, or take equity out of their homes.
When Should You Refinance a Home?
There are three primary reasons that people refinance their mortgage.
#1 Lower Your Monthly Payment
Lowering your monthly loan payment is one of the reasons to refinance. If interest rates have dropped or if you need more flexibility in your monthly budget, you can refinance and usually reduce the amount you have to pay each month.
Just keep in mind that if you lower your monthly payment by extending your loan’s term, that usually increases the overall cost of your loan. That's one reason why if you decide to refinance, make sure to shorten the term on the mortgage (in other words, go from a 30-year loan to a 15-year loan). While this may increase your monthly payment, it should decrease the total amount of interest paid.
#2 Lower Your Interest Rate
If interest rates have dropped since you got your mortgage or your credit has significantly improved, you could lower the interest rate on your loan by refinancing.
Reducing the interest rate of your loan will save you money in the long run and may help you reduce your loan’s monthly payment. A common move is to go from a 30-year to a 15-year mortgage, which usually comes with a lower interest rate. While overall payments are generally higher, the total interest paid over the course of the loan will be substantially less.
#3 Take Equity Out of Your Home
If you have a lot of equity in your home and want to turn that equity into cash to put toward something else—like paying for a child’s college education if you don't already have a 529 plan or other funds—refinancing is an option.
In a cash-out refinance, you get a new mortgage for an amount larger than the remaining balance of your existing loan. You pay off the existing mortgage and pocket the difference.
Keep in mind that cash-out refinances involve increasing your overall debt, which usually means a bigger monthly loan payment and a higher overall cost for your mortgage. However, mortgage rates are often so low that this may be your cheapest way to borrow money.
How Does Refinancing Work?
Refinancing works by replacing your existing mortgage with a brand new one. Because you’re applying for a new mortgage, the process of obtaining one is very similar to the process of getting a mortgage to buy a property in the first place, minus the stress of shopping for a home. Here are the steps involved in refinancing a mortgage.
Check Your Credit
The first thing you should do when you’re thinking about refinancing is to check your credit. You’re applying for a loan, so you want to make sure you have a good credit score that will make it easy to qualify for a loan and to secure a good interest rate.
If your credit score has dropped since you got your mortgage, you might find yourself struggling to find a lender to refinance with or you might face much higher loan costs.
Figure Out Your Goals for Refinancing
If your credit is in a good place, you can start thinking about why you want to refinance.
Do you want to save money on a monthly basis by reducing your interest rate? Are you trying to turn a 30-year loan into one that has a 15-year term instead? Do you want to turn some of your equity into cash to put toward other purposes?
Your reason for refinancing will guide your decisions down the line about things like loan terms.
Shop Around with Multiple Lenders
Take the time to look at multiple mortgage lenders and the loan terms they are offering. Each lender is free to set its own fees and interest rates. By comparing multiple options, you can find the best deal available. You may find the easiest way to compare is by asking the lenders to cover all the costs (fees, points) of the refinance without adding them to your current loan. Then all you have to do is compare the interest rates and take the lowest one. While that is not the way to get the lowest interest rate possible, it is the best way to compare apples to oranges.
Apply for a Loan
Once you’ve settled on your preferred lender, it’s time to submit your application.
Just like the first time you applied for a mortgage, the application process can be strenuous. Be ready to provide a lot of information and documentation, including:
- Your employment history
- Your income
- A list of your assets
- A list of your debts
- Recent paystubs
- The previous year’s tax forms
- Recent bank statements
If you’re married or applying for a loan with a co-signer, the other person on the loan will also need to submit these documents.
Lock in Your Rate
If you get an approval after submitting your application, your lender might give you the option to lock in the interest rate of your loan. Rates can change frequently, so if you want to secure the interest rate the lender offers, locking it in can be a good idea.
If you don’t lock in your rate, it could rise (or fall) before the time you close on the loan, which will change things like the monthly payment and the overall cost of your refinancing loan.
Paperwork and Appraisals
Just like when you purchased your home, your lender will go through an in-depth underwriting process to confirm all of the information you provided with your application. You might be asked to fill out additional paperwork as part of this process if the lender has any questions about the information you provided.
Your lender will also want to appraise your home to see how much it's worth. If you’re cashing equity out of your home, this will affect how much you can take out.
Once your lender has completed the underwriting process, it’s time to close on the loan. This is the final step in the refinancing process and usually involves a visit with an attorney or a representative of the lender.
You’ll have to sign your new loan documents and pay any closing costs involved with refinancing. If you’re cashing out equity, this is when you’ll get that money from the lender.
Once you’ve signed the paperwork, your refinance will be complete.
How Soon Can You Refinance a Mortgage?
For conventional loans, there’s no restriction on how soon you can refinance your mortgage after you get the loan. The exception is that you must have owned your home for at least six months if you’re trying to cash out your equity.
However, in practice, you don’t want to refinance your mortgage too frequently. Each time you refinance your loan, you’ll need to pay closing costs (unless you have arranged for the lender to pay those in exchange for a higher than market rate). Closing costs can easily total thousands of dollars with each refinance, so refinancing every month, or even every year, can get very expensive.
If you have an FHA loan, you must have had the loan for at least six months before refinancing. If you’re getting a cash-out refinance, the minimum wait is one year. You also must be current on the loan.
Can You Refinance a Doctor Mortgage Loan?
Most mortgages, including doctor mortgages, have no early repayment penalty (but always read the paperwork carefully when signing for a loan). That means you can refinance them at any time. With a physician mortgage, it can make sense to refinance into a lower rate conventional mortgage after a few years because generally:
- Your income goes up
- Your debt-to-income ratio goes down
- Your credit score goes up
- Your mortgage has been paid down (increasing loan-to-value to more than 20%), and
- Your home has appreciated (increasing loan-to-value to more than 20%).
So even if interest rates have not fallen, it can often make sense to refinance. If interest rates go down, that is an added bonus. Doctor mortgages are generally only for a home you are buying, so you typically do not nor cannot refinance from one physician loan to another, but every program is different and is almost constantly changing.
Have more questions about physician mortgages and what would be the best option for you? Look at the WCI-vetted list to help you sort it out.
What Term Length Should You Refinance Into?
When you refinance your mortgage, you’re replacing your existing loan with a new one. That means you have the option to choose a new term for your mortgage.
The two most popular mortgage terms are 15 years and 30 years.
Thirty-year mortgages typically have slightly higher interest rates but lower monthly payments. They cost more in the long term, but if your goal is to reduce your monthly housing cost, the longer term is one of the easiest ways to do that. Fifteen-year mortgages have lower interest rates and are cheaper overall but have noticeably higher monthly payments than longer-term loans.
If your goal is to save money overall, a 15-year mortgage is the better choice, but you have to be ready for the high monthly payment. Keep this in mind also. If you have been paying on a 30-year mortgage for a couple of years and then you refinance to a new 30-year mortgage, you'll end up paying for your house for 32 years instead of 30. And you might just pay more in interest than you would have if you hadn't refinanced at all.
There's also the option to take the 30-year mortgage but to pay it down faster. Here's an example: if your monthly mortgage payment is $1,000, you could pay $1,200 instead. That would put more money to the principal of the loan, and if you continue to do that on a monthly basis, you'd pay off that mortgage in less than 30 years anyway.
In all of these scenarios, your goal should not necessarily be to make a lower payment, but rather to own your home free and clear sooner.
How Much Does It Cost to Refinance a Mortgage?
When you refinance your mortgage, you’ll have to pay many of the same fees you paid when you first got your mortgage, including:
- Application fees
- Attorney fees
- Title insurance
- Appraisal fees
- Mortgage points
- Closing costs
If your existing mortgage has a prepayment penalty, you’ll also have to pay that.
Depending on the amount you’re refinancing, these fees can add up. Some lenders offer no-fee mortgages but typically compensate for this by increasing the interest rate of the loan. Make sure you recognize that not all no-fee refinances are the same.
What Is the Average Closing Cost to Refinance a Mortgage?
The cost of refinancing a home can vary widely depending on the value of your home and how much money you are borrowing with the new loan. According to Freddie Mac, the average refinance involves paying about $5,000 in closing costs.
Refinancing your home can help you lower your monthly payment, reduce the overall cost of your home, or turn your home equity into cash that you can use. If you’re in a situation where you can accomplish any of these goals, you should probably think about refinancing.
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