Refinancing 101

Refinancing is the process of replacing your original mortgage with a new mortgage that has a more favorable interest rate and term. Many people choose to refinance when they have home equity (the difference between the amount owed to the mortgage company and the home's value). In other words, refinancing is paying off an existing loan with the proceeds from a new loan. Refinancing lenders typically require a percentage of the total loan amount, in the form of "points," as an upfront payment. One point equals 1 percent of the total loan amount. The more points, the better, because a larger payment upfront results in a lower interest rate.

Pros
Refinancing can reduce monthly payments and interest rates, and allow people to choose a different mortgage company or take cash out of their home preceding a large purchase. Homeowners can also cancel their private mortgage insurance (PMI) with a mortgage refinance loan, as the home's value increases and the balance on the home declines. Some people refinance to switch between an adjustable rate mortgage and a fixed one. For those with balloon programs such as ARMs, refinancing allows someone to switch to a new, fixed rate before the entire mortgage balance is due at the end of the term (usually five to seven years). One other reason for refinancing is to consolidate other debts into one loan.

Cons
However, there are risks involved. People may incur penalties that can amount to $1000+ for paying down their existing mortgage with home equity credit. Make sure you have an understanding of the fees involved before committing to refinancing. Fees can account for 3-6 percent of your outstanding principal and include the application fee, title insurance and title search, the lender's attorney review fees, homeowner's insurance, the appraisal fee, and points and fees incurred in loan origination. Your savings in interest must exceed refinancing fees in order for refinancing to be worthwhile.

Interested in refinancing? Experiment with the home refinance calculator. To learn more about refinancing a home, watch the short video below:

What You Need to Know About Home Loans and Credit Scores

Lenders consider a variety of factors when issuing mortgage loans, including job history, debt-to-income ratio, income & assets, and the amount your down payment will be. However, their primary concern is credit score. It's important to check your credit report for errors and areas of improvement.


Your credit score may influence the type of loan you seek. FHA-insured loans generally have lower credit score requirements than conventional loans. It's often easier for a person to qualify who 1) lost a home in a short sale or foreclosure to get a new mortgage faster, and 2) has damaged credit. However, with an FHA-insured loan, you must pay mortgage insurance on the loan--which is often for the life of the loan, and higher than private mortgage insurance if you make a down payment of less than 20 percent.

Conventional lenders look more exclusively at credit score when issuing loans. Private mortgage insurance is automatically cancelled when your loan-to-value ratio reaches 78 percent.

The simplest way to boost credit score is to pay all your bills on time. Take these additional steps to boost your credit score over time:

• Pay off collections or judgments against you ASAP
• Update your over-the-limit and post-due accounts
• Reduce your credit card debt to no more than 25%  of your credit line on each card
• Don't open new lines of credit
• Don't close your credit card accounts (you'll be using more of your overall credit limit if you do)
• Use a credit card you haven't used for a long time, then pay the bill in full. This demonstrates your ability to responsibly handle credit. 

Want to know more? Read about how the FICO credit score is calculated and 7 mistakes that can lower your credit score.