Overview of the Mortgage Loan Refinance Process
If it has been a while since you went through your purchase mortgage loan — or if your original financing seems like a blur right now — you may be wondering what the mortgage loan refinance process will be like.
This detailed overview will discuss the basic steps and stages involved with your mortgage refinance, which is basically the replacing of your current mortgage loan with a new (hopefully better one) one.
As you go along, you’ll probably recall key points from your original home purchase financing. That makes sense, because a mortgage refinance is exactly like your purchase mortgage loan — except that you won’t have to deal with sales contracts, sellers or even real estate attorneys.
In the sections below, we’ll review the steps you’re like to encounter (or should go through) as you refinance your current mortgage loan.
- Value consideration
- Review current qualifications
- Compare interest rates
- Refinance preapproval
- Loan processing
- Loan closing
- Right of rescission period
1. Value Consideration
The vast majority of homeowners and property investors fail to bother with this first step, and many of them end up losing thousands of dollars in the process.
The truth is that not all loan refinancing makes sense. For many people who have owned their home for several years, a refinance to a lower interest rate may not make financial sense — especially if their new refinance loan has the same term as the original.
Here’s why…
- Waste of interest already paid. The bulk of your payments during the first years of your mortgage loan goes for interest (not principal). When you refinance with the same term as your original loan, you’re forced to repeat those initial years. All the interest you paid to date are wasted.
- Refinance closing cost. Your refinance is not free. You will have to repeat many of the closing costs you faced during your home purchase. [Note: think twice before you add your closing costs to your new loan! That seemingly benign tactic actually increases your principal and forces you to pay even more interest -- on your closing costs.]
- Additional years. A refinance to the same loan term as your original loan forces you to repeat the years you’ve already put behind you. More importantly, this means you’ll have to face more years of mortgage payments before your home is paid off.
An exception to this warning is if you don’t plan on holding on to your property more than a few years. If that is the case, then a refinance to another 30-year mortgage loan would make sense, because you’re only looking at the savings of the next few years.
On the other hand, the fact that your new mortgage will be a cash-out refinance loan does not waive this value consideration. If anything, a cash-out refinance mortgage makes this issue more important… because you’re removing your equity.
If you have been in your current mortgage loan for several years, a better cash-out alternative may be a second mortgage home equity loan or home equity line of credit (HELOC). Either of those two options would preserve the investment and savings of your current first mortgage loan, but still give you the cash you feel you need.
2. Review Current Qualifications
All mortgage loans, whether for your home purchase or your mortgage refinance, must examine the same credit and propertyqualifications at the time of your application and closing. Consequently, a refinance loan will force you to jump through the same loan qualification hoops as you did with your purchase financing.
When you apply for a mortgage loan, your mortgage loan provider will analyze the following loan qualification issues:
- Employment. Your mortgage lender needs to confirm that you are currently employed in a stable job. Your lender will want to document two years of continuous employment and strong probability of continued employment. If you are currently unemployed or have started a new self-employment, you may have a more difficult time getting financing.
- Income. Once again, your lender will need to calculate your debt-to-income ratio, to ensure that you have enough income to cover your mortgage payments, long-term debts and other living expenses. Your new mortgage payments and other long-term debts should be less than a third of your gross (pre-deduction) income. To expedite the loan approval, you should make photocopies of your two most recent pay stubs, W2s and tax returns.
- Credit. Each lender and loan program will have their own minimum credit score requirements. If you don’t know your credit scores, you should check all three FICO scores right away (just in case you have to do any credit repair). As you probably know, the best refinance rates are reserved for borrowers with excellent credit and NO recent late payments on their mortgage loan record.
- Assets. Just as with your purchase loan, your refinance lender needs to see that you have enough liquid assets to cover any out-of-pocket closing costs and two months of mortgage payments in reserve. You should prepare copies of your two most recent bank and/or asset statements to provide to your loan officer. But note that you don’t have to reveal all your assets — you just have to reveal enough to qualify for the loan.
- Property. Finally, you must show that you have enough equity to qualify for the loan. This will typically require a new appraisal. If your property value is below your loan balance, you may still be able to refinance to a lower rate if you have been making timely payments on your mortgage loan.
3. Compare Interest Rates
Now that you’re ready to shop for a refinance loan, don’t forget to take the time to compare interest rates.
If you have excellent credit, keep in mind that you’re in the driver’s seat. You’ll have so many mortgage lenders competing for your business. But even if you don’t have the best credit scores, it’s important to note that you do have options.
The best way to get started is to compare current interest rates for the specific loan program you’re interested in (and qualified for)… with various mortgage loan providers. Speak with multiple mortgage companies and brokers to see which one offers the best deal.
Fortunately, the web makes this easy for shopper. You can use various mortgage loan comparison sites to review programs, interest rates and closing costs from various lenders who serve your area.
As you zero in on your top choices, take the time to read some of the reviews about these mortgage providers. Again, the web makes it easy to view the ratings posted by other customers through services like Yelp, Angie’s List and even Google. Don’t be swayed by just one really positive or extremely negative review. Instead, see what the balance of positive versus negative reviews are, to understand which lenders seem to have more problems and complaints.
4. Refinance Preapproval
Once you’ve compared mortgage lenders and interest rates, you should take the next step of picking the top choice and applying for a refinance preliminary approval commitment from that lender.
If they’re unable to give you an actual loan approval commitment, albeit preliminary and full of conditions, move on to the next one.
The preliminary refinance loan approval commitment will check your credit record and provide a conditional loan approval for your refinance. You will need to satisfy the conditions, however, before you can close the loan.
Some of the main conditions you’ll encounter include the following:
- Income and employment documentation
- Satisfactory appraisal of the subject property
- Explanation and documentation for credit report issues
- Updates to your hazard (homeowners) and title insurance policies
Keep in mind that you never want to ask for loan approval commitments from multiple mortgage lenders, unless absolutely necessary. The reason is that every time you apply for a commitment letter, that mortgage lender will require your social security number and pull your credit report.
Each credit report inquiry that goes on your record will then put a temporary ding on your credit grade. The hit is small and temporary (it goes away after a few months), but if you do it enough times, it may become an issue… especially if your credit grade is already marginal.
In fact, that’s one of the reasons why applying for a preliminary approval commitment is in step 4 (and not part of your step 3 comparison stage). If any of the mortgage lenders you contact in step 3 asks for your social security number, you should NEVER provide it. Tell them that you’re comparing interest rates and mortgage lenders right now, and that you’ll apply for approval commitment shortly.
Only provide your social security number to the mortgage lender you have finally chosen. This is the best way to control who gets access to your credit records.
By the way, the mortgage refinance loan commitment also offers one very important benefit: you get to lock in your interest rate.
You should do this right away. Interest rates will fluctuate up and down every day. The actual interest rate may be lower on the day you close — but it may also be higher. Why gamble with a good thing, when you don’t have to do so.
As soon as you get the mortgage loan commitment, make sure to confirm your interest rate lock right away.
5. Loan Processing
As mentioned above, your preliminary refinance loan commitment will come with conditions that must be satisfied before your new refinance loan can be closed. That’s what happens during the loan processing stage of your refinance.
This stage can be as brief as three days, or it can take as long as three months, depending on the difficulty of the loan conditions listed. Fortunately, most mortgage lenders will assign a loan processor to help you deal with these conditions.
As soon as you receive the loan commitment, review the conditions and start getting them to your loan processor as soon as possible. If you are unclear about a condition or unable to provide requested documents, contact the loan processor or mortgage broker immediately for clarification.
In addition to the documents and information that you may be required to provide, the loan processor will also work on some underwriting conditions directly.
- Appraisal report. The loan processor will normally be the one to order an appraisal report to determine the current market value of the property. Because mortgage loans are typically a percentage of the appraised value, the appraisal report will determine the maximum loan amounts, as well as issues with the property that may need to be addressed.
- Employment verification. Although your pay stubs, W2s and tax returns will document your income, the loan processor will verify your employment status by contacting your employer directly.
- Title insurance. The loan processor will need to order a new title insurance report for the refinance. The title insurance is often one of the most expensive portion of the refinance loan, and one way to save money on this expense is to provide your original title insurance. The mortgage lender may be able to get an updated title insurance coverage from that original title insurance company — at a discounted price for you.
- Hazard insurance update. The loan processor will also contact your homeowners insurance agent to update the lender beneficiary clause of your hazard insurance policy. The “mortgagee clause” for new refinance lender must be inserted into your homeowners insurance policy, in place of the current lender’s clause.
- Condominium documentation. If the subject property is a condominium, the loan processor will need to contact the homeowners association representative to obtain necessary information about the condominium project, your association dues payment history and the condominium insurance policy. Just as with the hazard insurance update for standard homes, the loan processor must also update the condominium association’s hazard insurance policy.
- Payoff Statement. Finally, the loan processor will contact the current mortgage lender to obtain a payoff letter. This payoff statement will provide the exact amount the current lender will need to pay off the current mortgage balance and remove its mortgage lien from the property.
If you can, you should also ask your loan processor and mortgage broker what you can do to expedite their processing. It’s important to note that the mortgage refinance loan commitment you obtained has a time limit. You need to close the refinance withing that time period in order to keep the interest rate promised.
One way to help your loan processor’s job is to send requested documents right away and provide contact information for your personnel department (for employment verification), homeowners insurance agent and condominium association representative (if applicable).
6. Loan Closing
Once all the mortgage loan conditions have been satisfied, your mortgage lender will provide the final mortgage loan commitment.
However, even though all of the approval conditions have been resolved, the lender will also have closing conditions. The escrow or closing agent must make sure that all closing conditions have been satisfied before he or she can finalize the refinance and disburse the necessary funds.
At the refinance loan closing, just as with your purchase settlement, you’ll sign dozens of documents related to your new mortgage loan. The main items you’ll be signing will include the following documents:
- Loan promissory note
- Mortgage deed
- RESPA HUD-1 settlement statement
- Final Truth-in-Lending (TiL) disclosure
- First payment letter
The closing is typically handled at the offices of the title insurance company, escrow agent or the mortgage loan provider. Technically, the escrow or closing agent works for the mortgage lender.
That agent notifies the lender as soon as all closing conditions have been satisfied. Once the mortgage lender provides the disbursement authorization, the closing agent will finalize the closing and prepare the funds disbursement.
7. Right of Rescission Period
Unlike purchase loans, however, refinance loans do not disburse funds at the end of the successful closing… at least for homeowners refinancing their own homes.
Federal law gives borrowers three full business days to rescind or cancel their refinance loan, if they’re refinancing their primary residence. This three-day right of rescission does not apply for refinance loans for investment (non-owner-occupied) properties.
Because the borrower has three days to cancel the refinance, the closing agent will wait until the end of the rescission period before disbursing the loan funds. The closing agent will send a check to the current mortgage lender, per the payoff statement… using the funds from the new refinance loan. The current mortgage lender will then issue a release of mortgage lien upon receiving the full payment and send it to the closing agent, who will then record that lien release with the county.
If any of the funds are going to the borrower, the closing agent will also release those funds after the three-day rescission period. The closing agent will also provide the buyer with copies of all the documents signed at the refinance closing.
