Is a Refinance Considered a New Loan?

Have interest rates dropped since you took out your mortgage? If so, refinancing may let you lower your monthly payments. But what, exactly, does a refinance entail? Is it a quick and easy altering of your current mortgage, or does it require an entirely new loan?

Yes, a Refinance Is Considered a New Loan

Refinancing is more than just adjusting your mortgage – it requires replacing your existing loan with a brand new one with different terms.

The funds from your refinance are used to pay off your current loan (or loans if you’re consolidating a second mortgage or lien). From there, you’re effectively finished with your old mortgage and begin making payments on your new loan.

Why Can’t I Refinance and Keep My Current Mortgage?

It would be much easier to refinance if you could simply change the terms of your current mortgage. However, a mortgage is a legally binding contract.

This means that, as a borrower, your lender cannot alter your fixed interest rate, repayment period, or any other agreed-upon terms once you close. 

This works in your favor most of the time. This means that the lender can’t raise your rate later on if you get a 30-year fixed loan.

The down side, though, is that you’ll need a new loan to lower your interest rate or make other beneficial changes. At its core, refinancing is when you re-finance your property – quite literally, finance it again.

However, more than just contractual law prevents you from refinancing and keeping your existing mortgage.

Often, the lender you worked with to get your loan will not be the current owner of your debt. Mortgages are frequently sold on the secondary market. Most of these loans are packaged into mortgage-backed securities and then re-sold to institutional investors.

Because of the regulations and complexity surrounding this process, changing your loan terms and keeping your current mortgage is generally impossible.

Loan Modification and Mortgage Forbearance

If you are trying to refinance to lower your payment because of financial issues, you may be eligible for loan modification or mortgage forbearance. These processes allow borrowers at imminent risk of foreclosure to permanently alter specific loan terms or pay no (or reduced) payments for a set period.

In most cases, however, modification and forbearance are a last resort. These options are generally only available when you’ve missed several mortgage payments, meaning your credit will take a big hit. Similarly, finding a lender that will refinance your loan can be difficult once you’re behind on payments.

But if you’re having trouble making your monthly payments or believe you won’t be able to do so going forward, talk with your lender about their options for borrowers facing economic hardship.

My Lender Contacted Me About Lowering My Rate

Sometimes, your lender (or loan servicer) may advertise or contact you about refinancing and make it sound like you’re keeping your current loan with better terms. But even if the company pitches the refinance as an easy process, it is still a brand-new loan.

You will need to go through an in-depth credit check, verify your income, and generally have your property reappraised. However, you may have an alternative if you have a mortgage secured by the FHA, VA, or USDA. All three agencies offer streamline refinance programs, which feature a “low-doc” refinancing experience.

Even a streamlined refinance involves taking out a new loan, though.

What Is the Process for Refinancing?

For most homeowners, refinancing will be much like the mortgage experience when they initially purchased their home. During the approval process, your lender will need to:

• Dig through your credit report
• Document your qualifying income
• Compare your income to existing debts
• Order an appraisal of your home’s current value

How Do I Refinance My Mortgage?

So, how do you go about refinancing your mortgage? Here are the five major steps you’ll take.

1. Compare current rates and request quotes from a minimum of three lenders.
2. Use your loan estimates to force the lenders to compete to offer you the best deal.
3. Move forward with your chosen lender, providing any additional documentation they may need.
4. Have an appraisal completed to determine how much your home is currently worth.
5. Sign the new mortgage paperwork and pay for your closing costs.

How Much Are Refinance Closing Costs?

Refinancing involves paying closing costs much the same as when you took out your original loan. These costs are typically between 2% and 4% of the refinanced amount for conventional borrowers. Homeowners with other types of loans may pay slightly more. 

That’s because the FHA, VA, and USDA all have upfront fees attached to their mortgages. The FHA requires an Upfront Mortgage Insurance Premium of 1.75% of your loan amount. The USDA has an upfront guarantee fee of 1%, and the VA charges most borrowers a funding fee ranging from 0.5% to 3.3%. These fees can be rolled into the loan amount.

What Do These Fees Mean to Me?

If you were doing a rate-and-term refinance on your $300,000 conventional loan and had estimated closing costs of 3%, you would be responsible for covering $9,000. 

With the FHA, you could expect to pay an additional $5,250 and the USDA an extra $3,000. Homeowners with an existing VA loan could do an IRRRL refinance and only pay a $1,500 funding fee. 

However, VA borrowers aiming for a cash-out refinance could be charged a 3.3% fee, which would equate to an extra $9,900 in closing costs – nearly $19,000 in total.

Check with your lender about your exact upfront funding fee (VA), guarantee fee (USDA), or MIP fee (FHA).

Is Refinancing Worth It?

Substantial closing costs can prevent some homeowners from refinancing. If you’re only able to get a slight interest rate reduction or otherwise minimally cut your monthly payments, refinancing may not be worthwhile.

Calculating your refinance break-even point can help you determine whether or not you should replace your current mortgage.

The break-even point on your refinance is the number of payments it will take for your cumulative monthly savings to exceed the amount you’ll spend on closing costs.

You can calculate your break-even point by dividing your total closing costs by the amount you’ll save each month on your new loan.

For Example: Your original 30-year mortgage was for $255,000 at a rate of 7.5% with a monthly principal and interest (P&I) payment of $1,783. You still owe $250,000 and can refinance that balance at 6.5%. Your new P&I payments would be $1,580 – a savings of $203 per month.

At an estimated rate of 3%, your refinance closing costs would total $7,500. Dividing that figure by your monthly savings would show a break-even point of 37 months. 

This means you would come out ahead on your refinance after roughly three years. This may be a good deal if you plan to stay in your home and keep your new mortgage for the foreseeable future.

Who May Not Want to Refinance

In some scenarios, your break-even point may be shorter. In others, it could be far longer. If you were facing $7,500 in closing costs to lower your mortgage payment by $75, it would take 100 months – more than eight years – to break even. Few homeowners would consider this worthwhile.

You also may not want to refinance if you’re seriously considering moving in the near- to mid-future. Similarly, do you believe interest rates are falling and think you’ll refinance again? You might be better off waiting rather than paying for closing costs twice.

Another reason you may not want to refinance now is if you think you might want to pull out equity with a cash-out refinance before you break even.

You should also recognize that refinancing typically extends the length of your mortgage payments. One component of why monthly costs decrease when refinancing is that the loan amount is usually re-amortized over another 30 years.

You can choose a different loan term, potentially even one that matches your current expected payoff. For example, a 28-year fixed refinance if you’ve been in the home for two years. However, most borrowers – especially newer homeowners refinancing for the first time – don’t think to ask.

Do I Have to Refinance With the Same Lender?

One of the biggest misconceptions is that borrowers must use their current lender to refinance. In reality, you’re free to refinance with any bank or mortgage company you choose, so long as you meet their lending guidelines.

However, you may still want to refinance with your current lender or servicer if:

• You’re familiar and satisfied with the online portal and payment process
• Customer service has been excellent in the past
• They’re willing to offer a great deal to keep your business

Keep in mind that if your lender approached you about refinancing, they’re likely not offering you the lowest rate possible. Make sure to shop around with at least a couple of other companies so you’re aware of your different options.

Should I Refinance My Mortgage?

Refinancing involves taking out a new loan to satisfy your existing mortgage. Borrowers typically refinance to reduce their interest rate, although some do so to change other aspects of their loan. With a cash-out refinance, you can withdraw some of your home’s equity to use any way you want.However, refinancing comes with closing costs, which may dissuade some homeowners from going through with the process. To determine if refinancing makes sense for you, check out current refi rates and then apply with an experienced lender to discuss your borrowing needs and goals.