Refinancing a mortgage, simply

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by Charlie Park

Charlie lives with his wife and three daughters outside of San Francisco. He runs PearBudget, enjoys being outdoors, and really loves a good library.

Last week, Tsh shared her story of how to get a mortgage without a credit score. I loved her post, and am impressed by how intentional she and Kyle are about paying off their new mortgage.

“But money’s tight!” You’re saying. “I don’t have any extra cash to use to pay my mortgage off early!” I hear you, friend. Today we’re going to talk about a simple way that you can cut several years off your loan (or free up some extra money in your budget), by refinancing your mortgage. It’s not too hard, and we’ll cover the basics.


Photo by Images of Money

What is refinancing, anyway?

Back when Sarah and I bought our house, our mortgage’s interest rate was somewhere around 7%. At the time, people told us we were lucky to lock in at such a low rate. But over time, rates dropped even more. (Right now, they’re around 4%!)

Refinancing a house is basically trading in one mortgage for another one. The new mortgage will probably be slightly larger than what you still owe on the old one, but the interest rate will probably be less. The bottom line: You’ll probably pay less each month (in our case, $150 less per month), and you’ll probably spend way less over the course of the mortgage.

Having an extra $150 would give us more money for our budget, or we could keep paying that money towards our new mortgage, and we’d cut eight years off our payments without paying an extra dollar. It was a no brainer.

Should you refinance?

That’s a good question, and (as with all things money) it depends on a number of factors. If you can answer yes to the following questions, it makes sense to look into refinancing:

  • Have you had your mortgage for less than 10 years?
  • Are you currently paying more than around 5.5% in interest?
  • Are you going to be in your house for more than two years?

Each of those questions speaks to factors that affect mortgages, and the math can get a little tricky. Thankfully, there are free online calculators that’ll do the math for you and help you figure out if it makes sense to refinance.


Photo by Dave Kliman

How do I refinance?

1. Decide on your goal

If your primary goal is to free up money in your monthly budget, you probably want to go with a 30-year fixed-rate mortgage (what Sarah and I did). You’ll have a slightly higher interest rate than a 15-year mortgage, but there’s less due each month (and you can usually pay more than the minimum if you want to pay it off more quickly).

If you chiefly want to pay your mortgage quickly and with the least amount of interest possible, you’ll probably want to go with a 15-year fixed-rate mortgage (what Tsh and Kyle did). You’ll have to pay more each month, but you’ll be done with your mortgage in half the time.

One commonly-advertised kind of mortgage you’ll want to avoid is an adjustable-rate mortgage. (Avoid! Avoid!) These loans can change their rate over time, so your lovely low rate now can jump higher in years to come.

2. Shop around

It’s a good idea to get several quotes. We compared rates from both local and national banks, lenders at LendingTree.com, and Quicken Loans.

You’ll want to find out from the lenders:

  • What rate can they offer you?
  • What are all the fees associated with the loan and the refinancing?
  • Are there any pre-payment penalties with the mortgage? (Boo!)

We got rough rate quotes from all of them, and ended up going with Quicken Loans, because they offered us the best terms. (Although we like supporting a local bank with our checking accounts, we found that the national banks and large-scale lenders offered better mortgage rates.)

We worked with a great agent, Rob McKenney, who talked us through everything on the phone in about 10 minutes. (You can call him direct, if you want: 1-800-226-6308 x31992. I don’t benefit in any way by mentioning him!)

As you consider the offers from different lenders, check the fine print to be sure that the loans you’re comparing have similar terms (some lenders will try to bait you with a low adjustable-rate, then switch on you).

3. Paperwork!

After you’ve chosen your lender, they’ll need paperwork like income statements and copies of your tax returns. They’ll walk you through this. Our lender even had a slick online interface that showed what we still needed to turn in.

The lender will also do a title search to make sure you actually own the house and that there aren’t any liens on it or other things that might cause problems. They also might send out an appraiser to give them a good estimate of what the house is worth. (A good excuse to clean up!)

4. Sign the papers

Our lender sent a notary public to us to do the signing, but if you’re working with a bank, you’ll probably just go to their office to sign the papers. We signed the papers, and that was it. It wasn’t bad.

All told, it takes about a month (sometimes a little less) to go through the process. And, in the end, we have $1,800 a year to go towards other things in our budget!

Refinancing isn’t for everyone, but if you’re looking to free up some money — or pay down your mortgage faster — refinancing could make a lot of sense.

Have you refinanced recently? Did I miss any of the key hoops that you had to jump through, or considerations you had to factor in to your decision? And if you have refinanced, what did you do with the extra money each month?

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Comments

  1. We haven’t refinanced but the thought has crossed our minds. If we did refinance, the motivation would be to free up extra cash to pay towards our principal. We’re working hard to pay off our mortgage in 10 years or less — hopefully less!

  2. avatar
    Meredith says:

    Our problem is that we’re underwater in our mortgage. We have not missed a payment in the 5 years we’ve lived here, but that doesn’t seem to matter. Did you have to put money down? My husband and I are wondering if we could come up with 5% of our balance, would someone refinance for us. We really want to benefit from the low rates.

    • Those are good questions, and I’d recommend you give Rob a call at Quicken Loans (I put his number up in the post itself). He’ll be able to give you a firm answer on them, in just a few minutes.

      We did have to make a deposit ($500, I believe) up front, but that was then “deducted” from the total fees wrapped into the mortgage. It was nothing like 5% of the balance, but I’m not sure if/how an underwater mortgage would affect things. Rob could give you a good idea, though.

      I didn’t mention it in the piece, but we had to call around to find lenders who would work with us (at the time, we’d been self-employed for under two years, and most banks see that as risky and aren’t willing to issue loans), but we found a few. And I imagine your situation is (sadly) more common these days than ours was.

      Good luck with it!

    • I’m not sure when/if you last checked into refinancing, but recent lending practices have allowed homeowners that are underwater to be able to re-finance even without having to have missed a payment. There are eligibility requirements to qualify (HARP is one program that is available).

      If you’re wanting/needing to refinance, I would call a few lenders to determine eligilibility. Good luck!

      • avatar
        Martha says:

        We just checked on this program(HARP) with our lender, Wells Fargo, because we are in an upside down mortgage. We were not eligible, I think because our original loan is not a fannie mae or freddie mac loan.

        we are not eligible for anything it seems, it’s rather discouraging, we had a great down payment but bought at the wrong time.

    • I really appreciate this question as we have a similar situation and MANY, MANY, MANY people are underwater these days. It’s an important consideration, but I had no idea there might be programs that would refi if you are underwater. Will have to ask our awesome mortgage guy (my Brother-in-law) about that one as well!

  3. I just refinanced and we dropped almost 3 points! HELLO EQUITY!!!

  4. These are great tips, but….can I just have that pink house?

  5. avatar
    Jennifer says:

    What about closing costs? We figured the closing costs and fee associated with refinancing would eat up the small equity we currently have so we wouldn’t benefit by refinancing (short term). What if my husband lost his job and we had to move in the next year and we had no equity?

    • If it’s possible that you’ll be moving within the next two or three years, it probably doesn’t make sense to refinance. Let’s say our closing costs ended up being $3,000, but our monthly payment dropped by $150. We don’t actually save money on the total package until we’ve paid the new rate for 20 months (3,000 / 150 = 20). We benefit from $150 in cash each month, but we’d take a hit if we had to sell the house before we hit that 20 month mark. (That $3,000 would get added to the mortgage, so it’s not like we’d be out $3,000 right now.)

  6. We’re in the middle of refinancing right now. It’s been so frustrating to be underwater on the house, so we’re going through the HARP program so we can avoid mortgage insurance. We won’t end up with any extra money per month, since the payment will be almost the same, but right now we’re at 6% on an ARM and we’re going to 4% with our payments going towards principal.

  7. We have considered refinancing, but I worry about closing costs. I know I need to investigate before it’s too late, but it seems like something always comes up to distract me.

  8. We looked into refinancing last year and unfortunately were turned down by our mortgage provider. We’re one of those families who jumped into home ownership during the crazy lending time about 12 years ago. We’ve never been late on a mortgage payment and have never missed one, but our cash flow is very limited. We originally qualified with both of us working, but now I stay home with the kids and homeschool. We had hoped to take advantage of the lower rates and free up a bit more cash each month. My husband’s credit score was in the excellent category, but our lender denied our application on the basis of how much we still owe on the home and its now lower value. I’m wondering if we should have shopped around other lenders. At the time it was so disappointing to be turned down that we just sucked it up and have pressed on trying to make cuts elsewhere in our budget.

    • Absolutely check with other lenders! Your current mortgage provider might not be very motivated to help you refinance because they are getting your payments right now. Other banks or financial institution WANT your money, so they might be more willing to work with you… Yes, you have to be prepared to be discouraged again, but if you have a high interest rate now, the work to shop around could pay-off big time in the end. Good luck!

  9. We’re almost done with our refinance, pending the last bits of paperwork. We had talked about it a few years ago, but I’m glad we held off, because now we’re getting a 15-year fixed at 3.375%, dropping from almost double that rate (with a 30-year). I feel a big sense of relief to have this taken care of – although it was quite depressing to find out our home value has dropped by almost exactly the amount we’ve paid down so far.

    • so if your home value had dropped by almost the amount you had paid down, did you still have equity from your original down payment, or how did you maintain an 80/20 loan balance? we would love to refi into a 15 year to get the low rate, but we would essentially have no equity left and would need to pay mortgage insurance. we bought a lovely home (that we adore) but just at the wrong time (spring 2007).

  10. One issue that we encountered when we refinanced last year was that we bought at the end of 2007 when the market was high… our new appraisal, after we put $25K into improvements (bought the lot next door, fenced and landscaped, build a huge workshop w/ electricity, added granite countertops and wood flooring), was almost exactly the price we’d paid in 2007. If we hadn’t done the improvements, we wouldn’t have been able to refi because we wouldn’t have enough equity in our home after everything lost value. And, now we’re moving unexpectedly (hubby got new job in a different city, and it’s too good to pass up).

  11. I’ve looked into refinancing our primary residence, but I’m hesitant to give up a “no recourse” loan (loan with initial purchase of house) to a “recourse” loan, which I believe is standard with all refinances. Also, closing costs are expensive (even if added to the cost of the loan, not having to pay out of pocket). Since we are already making accelerated payments on our house, we would only save about $10k over the life of the loan by refinancing. For now, I have decided to hold off refinancing….as although an extra $150/mo. would be nice, having a non-recourse loan as protection if case my hubby loses his job (and is not able to replace it quick enough) seems a safer alternative. We also own other rental properties, so have other assets to protect. Is there something I’m missing?

  12. My husband and I were turned down for a refinance a year ago because we were underwater on our mortgage. We’ve been able to put quite a bit toward the house since then and are probably about even now. However, we had to move last fall for a new job and the house that we want to refinance is now a rental property. Do the refinancing “rules” change when dealing with a rental vs. a primary residence?

    • I’ve recently re-financed one of my rental properties to get lower rates for better cash flow. Rates are still low, but they are higher for investment properties than primary residence. Other than that, it seems other factors were about the same (debt-to-income ratio, etc.). You can count rental income towards total income, but lenders only take a certain percentage (75% I believe) to account for time unrented, etc. The other thing I found was, underwriting takes longer for investment properties…I would recommend to lock-in rate for 60 days.

      However, I don’t know if lenders will refinance a rental property that is “underwater”. You can check with various lenders, but usually LTV are stricter for rentals than primary residences.

  13. We just got the paperwork to start working on refinancing our mortgage. It would have been done already, but we had a baby in the middle of it. I can’t wait to get it rolling again. Thanks for the motivation!

  14. A friend once asked me about our mortgage. Although I usually don’t bring up the subject I had to tell her that we didn’t have one anymore. Her response to me was, “I didn’t think it was possible to pay off a mortgage.” I will turn 40 this year and we’ve been debt-free for about 7 years now. I just encourage everyone that if you truly look forward to the “other side” of a mortgage and take the time to dream about what it would be like, then you can find numerous ways to make it happen much sooner than normal. (Oh and follow Dave Ramsey’s plan…it totally works.)

  15. avatar
    shelley says:

    It’s interesting that you say to avoid adjustable rate mortgages. We’ve really benefited from ours. In the UK, the interest rate has been 0.5% for a couple of years now……we currently pay 0.39% above base rate, so our interest on our mortgage is less than 1%. Result! Over the course of a typical 25 year term, fixed rate and variable rates usually even out, but in the current economy, our rate is unbeatable! We will probably refinance once the economy starts to recover, but for now we’re sticking with what we have!!! We paid £300 extra a month while we could, but now with another baby on.the way (and the resulting reduction in income), we are enjoying the lower payments!

  16. We live in Indonesia and have different ‘rules’ on the mortgage stuff. One thing for sure: the banks make it easier for the civil servants. Since my husband (the one whose name is on the house) is a private worker, we got 10-year-fixed-rate mortgage. To get a cheaper house, we must buy one that’s even further than in the suburbs, but at least it’s our house.

  17. I was going to echo shelley’s thoughts on the Adjustable Rate Mortgage. If you can evaluate the terms, sometimes an adjustable can be an okay situation. Our ARM is structured so that the rate can only adjust once/year and the change cannot be more than 0.5%, so it would take several YEARS of increasing rates to get to a point where it would affect us. And… if interest rates start increasing, then home values (hopefully!!) should start increasing as well, which would put us in a better position to refi into a fixed rate. (Plus, luckily, our rate has been dropping for the last several years which has resulted in us being able to put more and more money against the principal.)

    It’s all a numbers game, and I know many, many people are trying to get out of that game completely, but since we’re already in it, this is just one thing that does work for us.

  18. I’m refinancing three houses this week (my primary and two rental properties.) This helped confirm that I’m doing the right thing–freeing up cash to slam my student loans into oblivion in a matter of months and then paying off my primary home.

  19. I appreciate these great tips!

  20. We bought in 2006. :( However, we also sold in 2006 so we are viewing the money we made as just a paper transfer to the down payment on this house. Our credit is over 800 but our equity to loan value is on the borderline and we don’t want to risk the $495 appraisal fee if we can’t refinance in the end. We have some liquid cash and instead of just paying extra on the mortgage, we are going to do a “recast” of our mortgage. The loan term will stay the same but our payment will drop because the overall loan value is less. Not all loan companies do recasting but it will nky be a $250 fee. And, once we get it all done, we could refinance to a lower rate because the loan itself would be significantly smaller. We can also just continue paying our current payment and pay the loan off in four to five years (which is the plan). We talked to our CPA about the whole mortgage interest comparison and he said we would be laying out three times the money to get back the deduction. Anyway, it it is different for every situation but recasting might be an option and is one that banks don’t publicize.

  21. Mortgage refinancing is a great way to pay the current home loan or current mortgage loan that you have taken. The collateral for the mortgage refinance is the same property.

  22. Hi there. My husband and I purchased a home 2 years ago and it was a USDA Rural Development Loan and our mortgage lender transferred it over to Chase. I am a little confused about the stipulations on it since it’s a Rural Development Loan. Since we have only lived it in 2 years (it was a new construction home), I’m pretty sure that we would not be able to refinance and have it be beneficial in the long run. We had an interest rate of 5.25% on $106,000 approx. I’m new at all this as we were first time home buyers.

    • Without knowing the specifics about your contact, it’s hard to know what the pros and cons would be for you. First-time home buying can unlock some good deals from housing development authorities. That being said, the rates are even lower now than they were when I first wrote this piece, so you might find it beneficial to swing by your local bank / credit union to talk to a representative. Take a copy of your current mortgage with you, so they can look it over and see if there are any specifics in the current contract you’d want to know about. Good luck with it!

  23. Just an idea for everyone- we found a local credit union with fantastic rates and a lot of leniency. They are willing to refinance up to 100% of the appraised value of our home, compared to most banks, which max out at 80%. Rates are as low as 2.75% for a 10-year fixed and go about to about 4% for a 30-year. If you haven’t looked at credit unions yet, give them a shot- they really are a wonderful alternative to traditional banks!

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