To refinance a home loan means to completely pay off the old loan and take out a completely new loan, usually with new terms, new interest rates, and/or pull out equity from the house.
Equity is the difference between the amount you owe on a home or property and what it is currently worth. For instance, if you owe $300,000 on a home but current market values place the home at $400,000, you have $100,000 worth of equity.
Refinancing may be a great option for a variety of reasons. Perhaps you want to consolidate debt and pay off credit cards, student loans, or the revolving credit. Perhaps the rates are better than when you first applied and you’d like to lower your interest rate. (If you can lower your interest rate by at least one full point, it will be well worth it). Maybe you want to do some remodeling on the house or change the terms, say, from a 30-year term down to a 15-year or even a 10-year term. This might be a great option if your finances have improved and you can make a little bit more on your mortgage payment each month. Paying off a mortgage 15 years or even 20 years earlier can save you hundreds of thousands of dollars in interest fees.
There are a variety of reasons someone would want to refinance. The key is to understand why you want to refinance and if it makes sense financially. You probably wouldn’t refinance to a higher interest rate unless you’re paying off debt that has a higher interest rate. You should run the numbers to see if this is a good financial move. Lowering your term is always a good financial move, even if you’re going up in interest slightly. By paying off the mortgage sooner you can save a lot more than what the interest rate would actually be saving you.
Some people pull out cash from their equity to pay for things like a remodel, paying down debt, and college tuition, or other major financial situations. If this is the case, lenders want to see you pull out no more than an 80/20 loan to value ratio.
Let’s go back to the $400,000 valued house with a $300,000 mortgage. Lenders usually will not let you take the full $100,000 in equity out. This means you will have maxed your loan and should you default, there’s no additional cushion for the lender to resell the property. If you owe $300,000, you could probably only pull out about $20,000 or $30,000, because any more than that would be over the 80% loan to value ratio. Lenders want to make sure that you don’t max out at a 100% loan to value ratio and you don’t want to either. Remember the subprime mortgage bust of 2007? This was a major problem. People were financing 100% of the home and when the home values dropped, they were actually underwater. This is the last thing we want for our homeowners. This is why this 80/20 loan to value ratio is a great idea for both lenders and homeowners.
Side NOTE: Surprisingly, underwriters don’t want to necessarily know you’re going to have a refinance to pull out cash for a remodel or upgrades to the house. They may think that there is something wrong with the house, even though it just may be outdated. They may actually prefer you take money out to pay off credit, or pay down the loan rather than improve the house, although that’s exactly what a refinance should technically be for in the first place.
The first thing to do when you start a cash-out refinance is to speak with a lender about the documents needed to apply for a home loan. Applying is easy. You simply fill out an application either online or in person with as much information as possible. Lenders will typically pull credit with your consent, which will give them exact figures on all of your assets and liabilities. With a credit score of at least 680, you should be able to get a refinance fairly easily and quickly depending on the type of loan you choose. These loans will take anywhere from two weeks to four weeks to completely fund. Anything lower than 620 takes a little bit longer but it is not impossible.
One thing to remember, when escrow, title, or your lender ask for specific documents it’s important to gather these papers as quickly and efficiently as possible. This keeps the process moving and keeps your loan on track.
Your lender may ask you to prove your identity, asking questions about past payments or debts, and may need certain documents or signed paper from tax return officials, creditors, or other lenders. Try not to get frustrated; it can be unnerving to pull up information from past financial mistakes, errors, or deals, but it is crucial to verify your identity and the right loan for your needs.
Your lender will keep you informed every step of the way. We will email you, call you, or text you, depending on your method of communication to keep you in the loop throughout the process. When the process is completed, escrow will call you for final signing. Because this is a brand-new loan, you will have the same type of documents as when you first find your mortgage. Bring your writing hand because you will be signing and initialing your name a lot.
Once completed you should receive your funds in a couple of days typically deposited directly into your checking or bank account.