How Does Refinancing My Home Work?

The ins and outs of replacing your current mortgage with a (hopefully?) better one.

Refinance

If you had the chance to save money on your mortgage payment — or get it over with sooner, or even use it to raise cash — you’d probably be interested, right? Of course you would! But when should you refinance, exactly? Is it even legit? What kind of scams are out there? What else should you know? Along with Jack M. Guttentag, a professor of finance emeritus at the Wharton School of Business, aka the Mortgage Professor, we’re going to renegotiate our expectations.

So should I refinance my home, or what?
That’s what Guttentag likes to call a “contingent question,” along the lines of, “Should I get a haircut?” It’s not really answerable without more information. Here, though, are some of the most common reasons to refinance: Lower interest cost; raising cash (perhaps for a remodel you couldn’t otherwise pay for); and protecting against possible rising rates in an adjustable-rate mortgage (ARM). Also: What’s your current loan like? What are interest rates these days? Can you afford more upfront fees right now?

Okay, slow down there. How does refinancing even work in the first place?
Interest rates are always changing for nearly every type of loan, right? Well, that includes mortgages. If rates today are lower than they were when you originally took on your mortgage, refinancing could, in theory, save you money, since you’re taking on a whole new loan at a lower rate. Lower rates will generally allow you to either lower your payment or shorten the loan term (say, from 15 years to 10 years).

Is the interest rate the only variable?
Not at all, there are lots of variables! You can renegotiate the rate and the term, as well as the mortgage points (which is basically like paying a cost upfront for a reduced interest rate, known as “buying down the rate”).

Wait… I can essentially just buy a lower rate?
Yes, and you could save a few thousand over the term of the loan, although you won’t really save any money unless you hold on to your house for a long time. Let’s say you pay for one point upfront, which costs you $1,000: That will get you a lower rate that equals a $10 lower monthly payment. It would then take 100 payments (so, eight-plus years), before you start realizing any savings off of it. But many people sell their home (i.e., paying off their mortgage) within eight years, so they won’t realize any savings.

What if I paid for points on my original mortgage?
Good point! If it was a recent mortgage and you refinance without realizing the savings from those points, you might wind up paying extra in interest.

When does it make the most sense to refinance?
Mostly when interest rates are lower than they were when you took out your original mortgage. Don’t worry, you’ll know pretty much right away if this is the case, because lenders often bombard homeowners with refinance offers when rates are low. Or perhaps you’re in a better place financially than before: Say, your credit score is much higher than it was and you could get a lower interest rate, since lenders would see you as less of a risk.

Can I refinance through anyone, or does it have to be my same lender?
You can refinance through anyone. In fact, Guttentag says, you’re probably better off going with another lender: For one thing, your current lender won’t be too eager to refinance a loan that they already hold, especially for terms less favorable to them. Still, when you shop around, include your current lender anyway — you just never know.

Does it cost money to refinance a mortgage?
Remember all those fees you paid for your first mortgage? You’ll be paying those again: Application fee; origination fee; appraisal; title search; document fees; recording fees and the rest. It all adds up to about two to four percent of the loan amount, so if you’re refinancing a $200,000 mortgage, expect to pay $4,000 to $8,000.

Ughhhh. Can I lower this at all?
Yeah, as with anything else that involves you forking over piles of cash, take the time to shop around, then negotiate with your lender. They may waive the application fee, for example, or allow you to use your previous appraisal.

I’ve heard you can consolidate other debts by refinancing. Thoughts?
Well, yeah, you can. Some people basically replace their high-interest debt — say, credit card debt — with the low-interest debt of a mortgage, by rolling it into a refinance. This is also known as a cash-out refinance, where you’re trading equity in your home for cash that you then use to pay off higher-interest debt — you’re swapping a high-interest loan for a lower-interest one. It’s a great idea in theory, but unless you’ve fully reformed your spending habits, this is essentially a license to bury yourself deeper in debt: Lost equity in your home; refinancing fees; more years of interest payments; and possibly continuing credit card debt (meaning, the high-interest kind). Choose this option carefully.

What if it’s an investment property, rather than my home?
Then it’s a little more difficult. The loan-to-value ratio (the current mortgage amount divided by the appraised value) typically needs to be lower (75 percent or less) on an investment property. Meaning, you can’t really refinance a property that you have very little equity in. Generally, most lenders insist that you have to own 25 percent of your investment property to be eligible for a refinance.

Are there scams involved in refinancing?
We’re talking about money, aren’t we? So yes, of course there are. If you get offers that first require you to fill out forms and disclose personal information, be very wary — it’s likely an identity theft attempt. If it doesn’t involve your current lender signing off on a refinance, that’s another giant red flag. If you’re asked to pay an upfront fee — or, especially, wire money — man, that’s a huge red flag and you should really know better. If, God forbid, you’re asked to sign over your home’s title, first, don’t do it, and second, call the FTC and the FBI. Finally, beware of phishing emails that look like they’re from a reputable bank. Check the sender’s email address closely, and don’t click on any links within the email.

What’s the easiest way to figure out if I can save money by refinancing?
Once you’ve shopped around to look at rates, use one of Guttentag’s mortgage calculators, like this one.

So… should I refinance?
If you can pay a lower rate, or get a shorter term, or you need the money in exchange for a bit less equity — and you can handle all the fees involved — sure, go ahead. It’s just gotta make sense for you. No one wants to be in debt forever and the less interest you have to pay, the better.