Refinancing a Mortgage

Refinancing generally refers to the process of getting a new mortgage loan and using the proceeds to pay off ones existing mortgage loan. It can also refer to obtaining a new loan on your car and using the proceeds to pay off the existing car loan. Businesses do the same thing with their debt, but with a business the process is generally referred to as restructuring of their debt while with consumers the process is referred to as refinancing.

People usually refinance home or car loans for one of three reasons:

1 to obtain a lower interest rate on the new loan and thereby lower their monthly payment.

2 to borrow against the equity that has built up in their home. This involves borrowing more than the amount of the existing loan and using the extra cash to either pay off higher interest credit card or other bills, to make improvements to the home, to buy a car or any of a number of other things.

3 to lower their monthly payment by obtaining a new loan at the same interest rate but for a longer term (repaying a 20 year mortgage loan with a 30 year mortgage loan)

The process involves completing and submitting an application for a new loan. Allowing the lender to run a credit check on the borrowers and, depending upon the lender and the condition of the home, having a new appraisal done. Also, depending upon the lender and the state in which the borrower lives, there may be some other requirements such as termite inspections, etc.

The buyer, of course, has to pay for the credit report, appraisal and any other inspections. The buyer will also be charged for updating the title insurance, filing fees for the new deed, and fees for various other services. All of these fees will be itemized on a form known as the RESPA statement which will be given to the borrower at or before the closing of the new loan. While these fees can add up, the significant fees are usually the loan origination fee, points, which are charges calculated as a percent of the loan, and prepayment penalties on the existing loan. One point is equal to 1%, so a 1% origination fee plus 2 points on a $100,000 loan would cost the borrower $3,000. Prepayment penalties can be as much as three to six months worth of interest on the existing loan. The prepayment penalty compensates the existing lender for terminating the loan contract early. Not all loans have prepayment penalties and you have to read your existing loan contract to see if the loan has one and, if it does, what the conditions are under which it can be charged. As to the loan origination fee and points, these help cover the new lender's overhead, pay the loan officer, compensate the lender for extra risk if your credit is bad, etc. Points can also be used to buy down or lower the interest rate on your new loan. When you buy down the interest rate you are, in effect, paying some of the interest in advance.

The first thing to understand about points and, to some extent, prepayment fees, is that you may be able to negotiate them depending upon how good your credit is and how competitive the market is. A few years ago, I had a high interest rate mortgage and was shopping for a new, lower rate, loan to refinance it. There was a prepayment penalty on my existing loan and there would be points on the new loan. Before I agreed to a new loan, I contacted my existing lender and told them I planned refinance and get a lower rate. They immediately offered to lower the rate on my existing mortgage (not quite as much as the new one but close to it) and I accepted because it saved having to pay the prepayment penalty, points and other fees on the new loan. Other people have been able to reduce points by either shopping around for a better deal or simply refusing to go ahead with the new loan until the points are lowered. To the extent that the loan officer has control over the points (and they usually do have control over the portion that is their pay) and ,if the market is very competitive, you can often get them to reduce the points. Also, the bigger your loan and the better your credit, the better your chance of reducing the points (since the time and paper work is about the same for a $100,000 loan as they are for a $200,000 loan, a loan officer can reduce the points from 2 to 1 on the $200,000 loan and make as much as she would from the 2 points on the $100,000 loan).

Points and prepayment penalties are very important because, when refinancing, the buyer rarely pays anything out of pocket beyond possibly the credit report and appraisal fees. Instead, all fees are simply added on to the new loan. However, part of the savings from the lower interest rate on the new loan will be eaten up by the fees paid for the new loan so, in some cases, there is no savings in the long run. In the links section I have added links to some finance sites which have calculators which help a person to compare costs and savings so as to choose the loan that provides the biggest real dollar savings and not just the lowest interest rate.

In closing, I would like to point out that the mortgage loan process in general and the refinance process in particular have become very streamlined and very easy. The intense competition in the lending industry is not only driving down rates and fees but is has also made customer service and convenience a priority. I refinanced my own mortgage about six months ago and the entire process was completed within three weeks and involved three or four short phone calls and two visits to our home by a mobile notary to sign papers. Everything was done at my convenience and my time and effort was kept to a minimum.