How to Refinance Home Loans: A Primer
With the average home loan rate standing at 2.7%, according to Freddie Mac , an army of U.S. homeowners are looking to refinance their home loans.
According to the Mortgage Bankers Association  The MBA’s Refinance Index was 46% higher in the first week of February than it was at the same time in 2020
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Mortgage Refinancing Loans Explained
What’s all the buzz over refinancing – and how can consumers cash in on the best deal? Start with some basic knowledge and take some key action steps moving forward.
First, the basics. Refinancing, by definition, is paying off an existing loan with a new loan that has different terms.
“Loans such as home loans and car loans are most commonly refinanced, and people refinance for good reasons” said Linda Chavez, founder and chief executive officer at Seniors Life Insurance Finder, in Los Angeles, Cal. “One reason might be to switch from an adjustable interest rate to a fixed rate. Another might be to change from a poor loan vehicle to a better one.”
Paying down loans faster is often cited as a top reason to refinance a mortgage loan. Just as typically, many people refinance in order to lower the monthly payments.
“For example, suppose you bought a house for $200,000 using a $180,000 loan at 5% interest for 30 years,” Chavez said. “Here, your monthly payment would be around $966. After living in the house for a number of years, you have paid down the loan to $150,000. You are considering refinancing with a 4% interest rate for 30 years.
Under the refinanced loan, you would pay off your original loan and start a new loan for the $150,000 at 4% for 30 years and the new the monthly payment would be around $716.”
“In that scenario, the monthly savings would be around $250, Chavez said.
There are downsides to mortgage refinancing and consumers should know the score before cutting any deals. “The main downside of refinancing is that it can be expensive,” said Omer Reiner, president of FL Cash Home Buyers in Fort Lauderdale, Fla. “Borrowers will need to pay all of the standard closing costs that come with negotiating a loan, such as mortgage origination fees, title insurance, application fees, and other related loan costs.”
In 2020, the average cost to refinance a home mortgage stood at $4,345, according to Value Penguin . Fees and interest rate costs can be significantly higher for borrowers with weak credit.
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Tips on Getting the Best Loan Refinancing Deal
Like any other big financial step, refinancing a long smartly takes a health blend of knowledge, due diligence, and timing.
Make no mistake, all three characteristics are in play right now, and as the old saying goes – there’s no time like the present. Take these tips to the table when you get going.
Know the playing field. There are two types of refinancing – rate and term and cash-out refinancing.
“A rate and term refinance allows you to take advantage of a lower interest rate by replacing your current mortgage with a loan with new terms,” said Alan Rosenbaum, chief executive officer at GuardHill Financial, in New York, N.Y. “With rates currently at all-time lows and starting to rise, now is a great time to refinance and potentially lower your monthly mortgage payment.”
A cash-out refinance allows you to replace your current mortgage with a higher loan amount, and the difference is cash available to the borrower. “Some benefits of a cash-out refinance include paying off student loans or covering the cost of a home renovation.”
Look for deals with multiple lenders. One of the most common mistakes to avoid is not shopping around when trying to find a lower rate. “Instead of just going back to your original lender or signing up for the first ad that you see, make a point to visit a few lenders,” Reiner said. “The difference of a few percentage points can be the difference of thousands of dollars.”
Plan ahead. Before looking for a mortgage refinancing deal, contact your lender to make sure there are no prepayment penalties on the loan you want to refinance. “Also, check your credit score to make sure it has improved since you first took out the loan,” Said Anna Serio, a commercial loan officer at Finder.com, in Sydney, Australia. “If it seems lower than it should be, request a free copy of your credit report to check for errors.”
Get prequalified. “If you think you’re in good shape to refinance, compare multiple offers available to people who live in your state with your income and credit score range,” Serio said. “Once you’ve narrowed down your options, prequalify with a few to compare potential offers.”
Use your prequalified offers to make a final decision and follow that lender’s instructions to go through with the application.” In many cases, your new lender will disburse the funds to your old lender,” Serio said. “ But in some cases, your new lender will send you the funds, which you can then use to pay off your current loan.”
Takeaways on Mortgage Refinancing
After those steps are complete, go ahead and apply for your mortgage refinancing loan – and use the money saved on a new mortgage wisely.
Done correctly, refinancing a home could be one of the best financial moves you’ll ever make.
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Brian O'Connell has been a finance writer at TheStreet, TheBalance, LendingTree, CBS, CNBC, WSJ, US News and others, where he shares his expertise in personal finance, credit and debt. A published author and former trader, his byline has appeared in dozens of top-tier national publications.