How and Why to Refinance Your Mortgage: A Step-By-Step Guide

By: Nick Cole
Updated: September 18, 2020 - 8:00 AM

Have you decided that the market conditions may be right to refinance your mortgage?

If this is your first time looking for an after-purchase loan, it might seem like an overwhelming task. After all, the process is different from purchasing a home, and there’s not a real estate agent or home seller there to press on you on the timeline. This one is all on you.

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But don’t fret. Team Clark is here to help you along the way. We have an evergrowing catalog of mortgage content that can help you make the right choices. In this article, we’ll try to break down the complicated task of refinancing your mortgage into easy, digestible steps.

A Step-By-Step Guide to Refinancing Your Mortgage

Before You Get Started

Before you get started on your refinance, you should do the math on your current mortgage, personal financial status and market conditions to make sure that a refinance is warranted.

Some Questions to Consider First

  • What is your current mortgage interest rate? If you took out a mortgage when rates were significantly higher than they are now, then you may be able to save thousands of dollars in interest over the life of the mortgage by refinancing.
  • What is your remaining mortgage term? Are you locked into a fixed rate with this mortgage? Or are you in an adjustable-rate mortgage (ARM) that could see a fluctuation in rate in the coming years? If you're looking to eliminate the uncertainty of a loan that can change based on things largely out of your control, a refinance into a fixed rate is probably a strong option.
  • How much is your remaining mortgage balance? If you're nearing the finish line on your mortgage and the remaining balance is relatively small, you may not want to add to the amount you owe by taking on closing costs that are associated with refinancing a loan.
  • How many years are left on your current mortgage? If you're itching to be debt-free sooner than you had originally planned, refinancing your mortgage could be a great tool for that. Moving from a 30-year loan to a 15-year loan, for example, will help you pay off your mortgage more quickly and likely will save you thousands in interest charges in the process. But use caution: Even with a lower interest rate, this is likely to raise your monthly payment.
  • How long are you planning to stay in your current home? If you know that your family is likely to try to "upgrade" to a new home or you might take a new job in a different city sometime in the next few years, you may want to consider holding off on refinancing.

Check Your Credit Score

This is a small, but important step in your prep work for a potential refinance.

Beverly Harzog, who is a consumer finance analyst and credit card expert for U.S. News & World Report, says:

"The lowest interest rates are given to people who have at least a 760 FICO score. You can save thousands of dollars over the life of your mortgage when you have excellent credit."

If your credit score is below 760 and you have time to improve it, you may want to wait until you can clear that threshold before applying for your new loan. It may be worth the wait.

Determine Why You Want to Refinance

“Refinance” is a buzzword that is popular when interest rates are low, but is it actually something you have a valid reason for doing?

Here are some popular reasons that homeowners choose to pursue a mortgage refinance:

  • Lowering an Interest Rate: If you have ever looked at the amortization schedule on your existing loan, you're likely well aware of the thousands upon thousands of dollars you're expected to pay in interest charges over the life of the loan. Lowering your interest rate is a way to reduce that amount considerably.
  • Reducing a Monthly Payment: This one can be related to lowering your interest rate, as owing less in interest goes hand-in-hand with owing less on your payments. However, you should be cautious when making a lower payment the leading indicator. Often this is simply a product of adding length to your loan, which could cost you more money in interest charges long-term.
  • Paying a Loan Off Faster: A lower interest rate could help you pay off your loan more quickly. And it could save you thousands in interest charges in the process. Clark always recommends refinancing with the goal of moving your payoff date forward, not backward.
  • Locking into a Fixed Rate: Some people may be paying on a non-conventional mortgage, such as an adjustable-rate mortgage (ARM). If you're looking to eliminate the uncertainty of a loan that can fluctuate based on things largely out of your control, a refinance into a fixed rate is probably a strong option.
  • Eliminating Mortgage Insurance: You may have taken a mortgage that requires a monthly private mortgage insurance (PMI) payment. If you have enough equity in your home, you might be able to eliminate that cost by refinancing.
  • Accessing Equity in the Home: If you have seen the appraised value of your home appreciate, you may be able to get a new mortgage that lets you access some of that equity. That's called a cash-out refinance. You'll be paying for this access by way of a larger mortgage balance, so be careful.

Once you have determined your “why” on the refinance, if you want to proceed, here are the steps for hunting down a new mortgage.

Step 1: Make a List of Lenders to Contact

Just like you probably wouldn’t buy the first car you see on the lot, you also shouldn’t jump at the first home loan offer you see on the internet.

Refinancing your house is a huge long-term financial decision. Taking the time to do some homework can save you thousands of dollars.

Money expert Clark Howard says that you should avoid big banks when searching for quotes on a new mortgage. Typically speaking, they don’t offer the best rates, they have slower turnaround times on refinances and they’re notorious for trying to tack on frivolous fees. Clark believes you’re better off by avoiding that potential headache.

Instead, Clark wants you to check with a mortgage broker and your local credit unions to get multiple quotes.

"You'll want at least four choices," Clark says. "If you're happy with them, go to the place where you took out your original loan. Then go to the place where you normally do your banking business, go to a mortgage broker and then to a credit union.
"And really, you can go much further than those four if you'd like. Because after you have those, you can go to online lenders. You can shop on your phone, you can shop on your laptop and you look at places like Rocket Mortgage."

Step 2: Get Quotes

Once you’ve narrowed your list of potential lenders, it’s time to see what each has to offer.

Questions to Ask While Getting a Quote

  • What is the interest rate? You'll see interest rates promoted all over websites, TV commercials and billboards, but many of those are "best case scenarios" in limited time promotions. Make sure each lender gives you a straightforward quote that clearly defines the interest rate you qualify for and how long that rate offer is available to you.
  • Are there any points required to get this rate? Sometimes called prepaid or mortgage points, these "points" are essentially a prepayment on mortgage interest charges in exchange for a lower interest rate. This ensures that the bank makes money on the loan earlier in the process, and that's not necessarily a good thing for the borrower. Clark says the only people who should consider paying points on a loan are those who are sure they're going to be in the home for the very long term.
  • How much are closing costs going to be? Unless you're getting a no closing cost loan, you're going to incur some expenses for processing your loan.
  • Are there any "junk fees" involved? These are unnecessary or frivolous charges that may be tacked onto the final cost of your loan. Clark hates these, as they can turn an otherwise attractive loan into a bad deal. It may not be fun to comb through the details, but make sure that each fee you're being asked to pay is necessary.

Clark’s Ideal Quote

Clark wants you to get the lowest rate possible, but he also wants you to avoid unnecessary fees. That includes exorbitant closing costs, which could set you back on your balance owed if they get rolled into the loan. For that reason, he says some people may be best suited for a no closing cost loan.

He also wants you to make sure that refinancing helps you move your payoff date forward — not backward.

"One of my favorite kinds of refinancing is going from a 30-year loan to a 15-year loan. If you have more than 23 years left on a 30-year mortgage and you refi into a new 30-year loan, you'll extend the time you're in debt," Clark says. "But if you choose a 15-year loan instead, you'll cut your interest rate even more and pay off the mortgage sooner."

Remember to go through this process with multiple lenders. You'll want a clear picture of the pros and cons of each type of loan they offer so that you can choose which is best for you.

When it comes to comparing quotes, you’ll also want to make sure it is an apples-to-apples comparison. Don’t judge a rate with no points vs. a rate with a point required, for example.

When Will There Be a Hard Pull on Your Credit?

You may be asked to give permission for a hard pull on your credit during the quote process. It depends on the policies of the lenders with which you're working.

I spoke with representatives from two credit unions, and they both said their organizations request hard credit pulls during the quote process.

LendingTree is a free online quote service that shops your information around to many lenders. Its website says its initial inquiry on your credit does not impact your score. However, the site also says that partner lenders who get your information through LendingTree may do their own credit checks:

LendingTree pulls your credit report when you complete a loan request. LendingTree's inquiry does not count towards your credit score nor does it show up on your credit report to anyone but you.
Each Lender has their own policy about pulling your credit. Some may pull your credit before they make you a loan offer; others may pull your credit after you have accepted their offer. In all cases, LendingTree pulls your credit report when you complete a loan request.

Once your credit information has been pulled, the clock starts ticking. You will have a period of up to 30 days (depending on the scoring service) during which multiple lenders can do credit checks without any adverse impact on your credit score. This lets you shop around without doing further damage to your credit rating.

Clark advises gathering all of your quotes within 14 days of the date you requested your first quote. Late in this article, we’ll talk more about why Clark considers that two-week deadline to be so important.

Step 3: Crunch the Numbers

Now that you have a few refinance quotes, you are ready to use Clark's mortgage refinance calculator to see if this transaction is a good idea.

But, first, you should familiarize yourself with Clark’s breakeven rule: it’s the foundation on which the calculator is built.

Clark’s Breakeven Rule

Clark has a special rule he likes people to use when they are considering whether a refinance is worth the costs associated with it.

While Team Clark has a more in-depth breakdown of this philosophy here, the quick pitch on it is this: Clark wants you to break even on your refinancing costs (closing costs, points, etc.) within 30 months in interest savings alone.

"If you can make back the cost of the refinance in 30 months or less, you should do it," Clark says. "It just makes financial sense. That's the trigger."

It's important to note that Clark is talking about making the closing costs back in 30 months solely through interest savings, not payment savings. Interest savings is a true measure of cost recuperation. It could look like you're saving money if your monthly payment goes down because of a longer loan term. But in long run, that does not save you money.

Clark’s Mortgage Refinance Calculator

Clark's mortgage refinance calculator not only gives you the financial specifics of a transaction, but it also gives you tangible and actionable advice based on the breakeven rule we just discussed.

You can plug your information in here for guidance:

[ Close ]

Mortgage Refinance Calculator

  • Current Mortgage Details

  • This is the amount of the loan when you first took it out.
  • Mortgage loans are usually 30 or 15 years. If your current mortgage is an ARM, it will still usually have a total mortgage term of 15 or 30 years. If you are unsure, check with your current mortgage company.

  • New Mortgage Details

  • This will usually be 30 or 15 years, but is sometimes 10 or 20 years.
    There are several options for handling closing costs. You can simply pay them at the time of closing. You may also have the option of adding the closing costs to the amount you owe on the mortgage - that's usually called "rolling them in". Some lenders also offer a true no closing cost loan, but this usually means the interest rate you pay will be higher.
  • Almost all loans have closing costs. The lender should be able to give you an estimate of the closing costs on the new loan. If you aren't working with a lender yet, you should estimate closing costs of 1.5% of the mortgage amount. For example, a $300,000 mortgage would have closing costs of $4,500.
  • This is usually a number between 0 and 2. Not all loans have points. Points are a way to pay for interest costs up front to lower the interest rate on the loans. When comparing loan rates, you should always compare the rates with the same number of points. It is best to compare loan rates with zero points.
  • A cash out refinance is when you finance more money than the total amount owed on the home. This is sometimes done to pay for extra projects on a home (such as a pool or remodel), or it can be done to consolidate debt. The additional money borrowed is rolled into the total amount of the mortgage.

Some Key Details for Using Clark's Mortgage Refinance Calculator

  • You need info for both loans: For this calculator to give you accurate information and advice, you will need to have the details on both your current mortgage and your proposed new loan. The more data you're able to give us, the more accurate the advice can be.
  • Prepayment Caveat: If you have made a significant prepayment to your existing mortgage, that could impact the accuracy of the data you receive. Our calculator, like most you'll find on the internet, is built to judge your savings based on the amortization schedule of your original loan. Prepayments, while a great idea for paying a loan off early, don't reflect in your progress on the amortization schedule.

Your Results

Your monthly payment will go up down {{ calc_change_in_paymentDisplay }} {{ calc_change_in_paymentDisplay }} per month.

Your payment is going up because you shortened your payoff from {{api_hom02_currentTermO/12}} years to {{api_hom02_traditionalTerm/12}} years.

Your new monthly payment will be {{api_hom02_traditionalPaymentDisplay}}. This amount does not include insurance and taxes.

Your new mortgage will be paid off in {{ calc_refi_payoff_year }} instead of {{ calc_current_payoff_year }}. You have added {{calc_change_in_payoff_yearsDisplay}} years to subtracted {{calc_change_in_payoff_yearsDisplay}} years from  your loan period.

If you refinance, you will save {{ calc_change_in_total_interest_costsDisplay }} in interest over the life of the loan compared to what you will pay in interest if you do not refinance.

If you refinance, you will pay {{ calc_change_in_total_interest_costsDisplay }} more in interest over the life of the loan compared to what you will pay in interest if you do not refinance.

Is it worth it to do this refinance?

Clark’s simple rule:
“If you can make back the cost of the refinance in 30 months or less, you should do it.” - learn more about this rule.

Your new mortgage will pay for the {{calc_total_cost_of_refinancingDisplay}} cost of refinancing in {{ clark_calc_interest_breakeven_months }} months.

If you refinance your mortgage, you will never save enough interest to pay for the {{calc_total_cost_of_refinancingDisplay}} cost of refinancing. Refinancing your mortgage is probably not a good idea.

Based on Clark’s rule of thumb, doing a refinance is probably a good idea as long as you plan to stay in your home for more than {{ clark_calc_interest_breakeven_months }} months.

Based on Clark’s rule of thumb, your payback period is longer than he normally recommends. For this refinance to make sense for you, you will need to be sure you are going to own your house longer than the {{ clark_calc_interest_breakeven_years }} years it will take to pay for the cost of the refinance.

Even though you will be able to pay for the cost of refinancing in less than 30 months, you will actually be paying more in total interest over the life of the loan. What this means is that this refinance is a good idea in the short term, but in the long term it will cost you more money. You should consider refinancing into a loan with a shorter term. This will give you the benefit of lower interest costs in the short term and the long term.

Not only is the breakeven period longer than Clark recommends, but this refinance will also cost you more in interest over the life of the loan. If you think you will be in your home long enough to pay for the cost of refinancing, and you want to also save money over the life of the loan, you should consider a loan with a shorter loan period.

In your first payment, you will be saving {{calc_change_in_first_interest_paymentDisplay}} in interest costs.

See your full amortization schedule

What if you want to pay extra principal and pay off your new mortgage in the same year, {{calc_current_payoff_year}} as your current mortgage?

Your current mortgage is scheduled to be paid off in {{ calc_current_payoff_year }}, and your new mortgage is scheduled to be paid off in {{ calc_refi_payoff_year }}.

If you pay {{calc_additionalal_principalDisplay}} in additional principal payments each month, you can pay off your new mortgage in {{ calc_current_payoff_year }}, just like your current mortgage.

Paying this extra amount will save you {{ calc_enhanced_change_in_total_interest_costsDisplay }} dollars in interest over the life of the loan.

Step 4: Choose a Lender and Lock-in the Rate

While you should have 30 days to shop around on quotes before your credit rating takes a hit, Clark says that you should make a decision on your new loan and lock it in within 14 days of requesting quotes.

"It's supposed to be 30 days, but if you look at what the credit bureaus say, I'm more comfortable with completing the process in 14 days," Clark says. "That way people are focused on it, and there's no chance they're going to get more than one inquiry figuring into their credit score.
"The beauty of setting a goal of getting all your quotes within two weeks is that you're going to be consistent in the questions that you ask. If you let it go over many, many weeks, the rates could change and your questions could no longer be the same."

When you’ve arrived on the quote that offers you the best terms, you’ll want to contact that lender and ask to lock in your rate.

Loan Estimate Form

Once you have confirmed you’d like to move forward with a lender, you can expect to receive a three-page document titled the “Loan Estimate Form.” This has replaced what used to be known as a “Good Faith Estimate.”

The Consumer Finance Protection Bureau offers the following tips for evaluating this form:

  • Check the spelling of your name
  • Verify loan term, purpose, product and type are correct
  • Ensure that your rate is marked as locked
  • Verify the loan amount is correct
  • Verify that your loan is either fixed-rate or variable-rate based on your quoted loan type
  • Check for things like prepayment penalties or balloon payments
  • Make sure that the monthly payment estimate lines up with your expectations

You can view a sample of the Loan Estimate form at the Consumer Finance Protection Bureau website link above.

Where to Hold Your Closing Costs

Once you’ve locked in your rate and know approximately how much money you will be required to pay at closing, you may be wondering how to handle that money between now and the closing date.

Team Clark suggests that you consider parking it in a high-yield savings account. This helps you accomplish several things at once:

  1. Accrues a modest amount of interest on your money while you wait to close
  2. Keeps the money liquid so that you can access it whenever the lender needs it (closing dates often can change)
  3. Protects your closing money from the short-term ebbs and flows of investment accounts
  4. Keeps you from using the closing money as a part of your everyday spending

Step 5: Gather the Documents

When it comes time to process your loan, the lender is going to do a more detailed evaluation of your finances to ensure that you are not a high credit risk.

While each lender may have its own list of financial documents it requires, here are some items you can expect to be asked for:

  • Payroll verification documents (pay stubs)
  • Personal tax documents (W-2 or 1099)
  • Bank statements
  • Statements on any outstanding debts (car loan)
  • Proof of any claimed personal assets (retirement funds)

Note that the evaluation process will extend beyond your personal finances. It also will feature an assessment of your property including a professional appraisal of the home and market analysis of home values in the area. The lender will want to make sure that it’s not throwing more money at a property than it’s worth to them if you default on the refinanced mortgage.

Step 6: Close Your Loan

Once the lender is comfortable with the financial information you provide and the information on your property, they will likely contact you to set up a closing date.

This process may be similar to what you experienced when you closed on your original loan for the property, but it probably won’t last as long.

You can expect this transaction to happen under the supervision of a title company, though some refinance closing transactions may just be recorded by a notary. If you are required to bring funds to the closing, you’ll likely need to be prepared to bring a cashier’s check or execute a wire transfer.

In my experience, the closing will require less than an hour of your time and will also require your signature on an extraordinary number of documents. Always remember to take your time and understand exactly what it is you’re signing. Ask questions if you’re unsure of anything. After all, you’re the person who is signing to take on years of financial responsibility here!

Beware of Fraudulent Activity

In the days and hours leading up to the closing on your refinanced loan, you’re going to want to be on high alert for suspicious phone calls, emails or documents. This is a time when scammers try to prey on unsuspecting homeowners who are expecting to move large amounts of money at closing.

If you give the wrong person sensitive information about a wire transfer, for example, they could steal thousands of dollars with little way for you to get that money back.

Clarks says a popular way this happens is when a potential scammer manages to hack into the email account of a mortgage lender, real estate lawyer or title company.

Once they’ve cracked the password of the vulnerable party, the scammers sit back and wait for sensitive loan information to be sent via email. And then they step in:

"They impersonate that individual and send false payment instructions for wires," Clark says. "And you could end up wiring money to the crooks instead of to the closing.
"Now, what you'll always want to do is get verbal confirmation from where you're making the wire to [before sending]. You want to talk to the individual with the closing attorney, title firm or whoever just to verify those instructions."

When phone calls are required to confirm the wiring of money, Clark says he asks to be the one who makes the phone call rather than receiving it. That is an effort to avoid the chance that a scammer is impersonating one of the parties handling the transaction.

Always make sure that you verify the identity of the lender, bank or other party involved before you divulge any sensitive information over the phone or by email.

Final Thoughts

For most people, their home is one of the most expensive investments of their lifetime. So it’s important to make sure that you’re diligent in the refinancing process.

To recap, here are some of the important steps you should take:

  1. Do your homework on your current loan, future plans and market conditions to see if refinancing is a feasible option.
  2. Shop around for multiple reputable lenders with whom you'd like to do business. These options ideally will include mortgage brokers or credit unions.
  3. Get quotes from multiple lenders, taking care to ensure that you ask all questions and gather all information within a 14-day window.
  4. Crunch the numbers with our mortgage refinance calculator to help you pick out the most beneficial loan options from the quotes you got.
  5. Lock in your rate and gather the necessary documents for your new loan.
  6. Beware of scammers as you prepare yourself for the financial transactions associated with the closing meeting.

If you complete these steps successfully, you should be well on your way to having a new mortgage loan that you can feel confident is a net benefit in your life for years to come.

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[ This article was originally published on Clark.com ]

The post How and Why to Refinance Your Mortgage: A Step-By-Step Guide appeared first on Clark Howard.