How Mortgage Refinancing Works?

Curious about how mortgage refinancing works? It's something that you need to learn, because if you're a homeowner you can save thousands of dollars each year by refinancing your mortgage loan. What homeowner couldn't use a savings of $1,500 or more each year?

You can save this money by refinancing your mortgage loan from one with a high interest rate to one with a lower one. If you are paying off a 30-year fixed-rate mortgage with an interest rate of 6 percent, you're paying $1,199.10 a month. If on the same loan you dropped your interest rate to 5 percent, you'd pay $1,073.64. That's a difference of $125.46 each month, or more than $1,500 a year. In mid-March of 2010 the average interest rate on a 30-year fixed-rate mortgage stood at 5 percent. That's not an all-time low, but it's still an incredible rate. If your mortgage loan is a point or more higher than this 5-percent rate, it might be time to consider a mortgage refinance.

Applying for a mortgage refinance can be a laborious process. First, you'll have to find a lender with which to work; you do not have to work with your existing home lender or bank. Once you find a lender, you'll have to send your loan officer copies of such financial papers as your last two paycheck stubs, your most recent federal income tax return, savings and checking account statements, your most recent credit card bills and other loan statements. Your lender will look at this paperwork to determine that your monthly debt obligation, including the estimated cost of your refinanced loan, is less than 36 percent of your gross monthly income.

Your lender will also order a credit check on you. This will give him your three-digit credit, or FICO, score. This number tells lenders how responsible you've been with your finances. If your FICO score comes in at under 620, you might not qualify for a refinance from a traditional lender. If your score is 720 or higher, you'll most likely qualify for the lowest interest rates.

Your lender will send a real estate appraiser to your home, too. The appraiser will determine how much your home is worth. This, too, is important: If your home has dropped in value since you purchased it, you might not have the 20-percent equity that lenders demand. This isn't an unusual situation; "The Wall Street Journal" in 2009 reported that in the third quarter of 2009 about one in every four homeowners owed more on their mortgage loans than what their homes were worth.

If your credit scores and equity levels are high enough, and your debt-to-income ratio is low enough, your mortgage lender will probably approve your refinance request. If this happens, you'll agree to a closing date on which you'll sign the papers, and pay any fees, that make your refinance, and the lower monthly mortgage payments it brings with it, official.

Resources:

Federal Reserve Board

Making Home Affordable