A refinance, which pays off your current mortgage with a new loan's proceeds, allows you to tap into your home's equity or obtain more favorable loan terms. Refinancing to cash out on home equity entails qualifying for a loan amount that's higher than your current mortgage balance. A no cash-out refinance allows you to change your interest rate and lengthen or shorten your repayment term. Refinancing involves many of the same closing costs as a purchase mortgage.
Lender Orders A Home Appraisal
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One of the first things a mortgage lender does when qualifying you for a refinance is order a home appraisal. Your home is the collateral that secures loan repayment, therefore, the lender verifies that the home has a high enough value to cover the new debt. An acceptable refinance loan-to-value, or LTV, generally ranges between 95 percent and 80 percent, translating into equity of 5 percent and 20 percent. LTV is the difference between a home's value and the loan amount. An independent appraiser performs a property inspection and analyzes recent sale data of comparable homes to determine your home's value. You typically pay for a home appraisal upfront, although some lenders allow you to add the fee of approximately $400 to a refinance's closing costs.
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Lender Lets You Know Your Options
The lender calculates the maximum amount you can borrow and advises you on refinance options after reviewing your home appraisal, credit and finances. Your borrowing power depends on debt-to-income ratios, or DTI and credit score_._ DTI is the percentage of monthly gross earnings used to pay housing expenses, including principal, interest, taxes and insurance, or PITI. A second, and equally important DTI figure, this measures the percentage of income that goes toward total expenses, including housing and recurring debt, such as auto loans and credit card bills. A housing DTI of 28 percent or less, and a total DTI of 36 percent, is recommended. In general, the lower your DTI and LTV, the more refinance options and the better your refinance terms.
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The most common types of refinances are:
- Rate-and-term or no cash-out refinance, which simply allows you to obtain more favorable mortgage terms. For example, you can get a lower interest rate, change from an adjustable-rate mortgage to a fixed-rate loan, and get a 15-year repayment term, instead of a 30-year term.
- Cash out refinance, which allows you to take equity out of your home, but usually results in higher monthly payments.
- Streamline refinance, which requires minimal credit analysis, paperwork, and sometimes, no appraisal. In general, a streamline refinance must lower your monthly payment.
Disclosing the Closing Costs
Lenders provide a Good Faith Estimate of the fees involved in your refinance within 3 business days of your application. You can use the estimate to shop and compare loan fees among lenders and third-party services, such as title and escrow. Just as refinance interest rates and terms are negotiable, many closing costs are negotiable, such as a lender's origination fee, or points. However, you can't bargain with certain costs, such as prepaid or past-due property taxes due at closing.
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Ask the escrow company for a copy of the HUD-1 Settlement Statement before you go to the closing table. Allow yourself sufficient time to compare the final closing costs on the HUD-1 with the lender's initial Good Faith Estimate. You may contest certain fees that were not originally disclosed or that have changed significantly without prior disclosure.