Refinancing your home mortgage could save you money by lowering your interest rate. You might also be able to tap into the equity you've built up in your home. In 2020, mortgage refinance activity reached a level not seen since 2003, as homeowners scrambled to take advantage of historically low rates. But before you decide to refinance, here's what you should know.
- Mortgage refinancing involves taking out a new home loan to pay off your existing one.
- Refinancing a mortgage can lower your interest rate and monthly payments and save you money over the life of the loan.
- You can tap into your accumulated home equity with a cash-out refinancing.
- Qualifying for a new loan is based largely on your credit score, income, and current loan-to-value ratio.
Understanding Mortgage Refinancing
Refinancing a mortgage means taking out a new home loan to replace an existing loan. The new loan can be from the same lender or a different one. When you're approved for mortgage refinancing, the old loan is paid off and you make payments to the new one going forward.
The mortgage refinancing process is similar to getting a mortgage in the first place. That includes an assortment of closing costs. According to Freddie Mac, homeowners pay $5,000 on average to cover the closing costs for a refinancing. One difference is that unlike you would for an original mortgage, you're not required to come up with a down payment when you refinance.
Lenders may allow you to roll closing costs into the new mortgage, though doing so will increase your monthly payments and the total amount you owe.
Benefits of Refinancing a Mortgage
Refinancing a home loan can be a time-consuming process, so it's important to weigh the potential benefits before proceeding. The most common reasons homeowners refinance include:
- Taking advantage of lower interest rates
- Reducing monthly payments
- Switching from a fixed rate to an adjustable rate or vice versa
- Extending or shortening the loan repayment term
- Accessing some home equity through a cash-out refinance
- Eliminating private mortgage insurance (PMI) payments
If your goal is to save money through refinancing, you'll also want to consider your break-even point. That's the point at which the money you're saving with the new loan begins to exceed the amount you had to pay in upfront closing costs. Breaking even can take months or even years, so refinancing may not be a wise move if you don't expect to stay in your home for that long.
If cash-out refinancing is your goal, you'll want to determine your loan-to-value (LTV) ratio. That's how much you still owe on the home versus what it's worth. This is important to know early in the process because lenders may cap the amount of equity you can withdraw based on your LTV. If refinancing won't provide as much cash as you're hoping for, you may want to wait until you've accumulated more equity.
Like other mortgages, cash-out refinance loans require you to use your home as collateral, so you could risk losing the property if you default.
How to Refinance Your Mortgage
Refinancing involves a number of steps, even before you apply. Here's how to go about it, step by step.
Check your credit
Lenders will check on your credit score and credit history when you apply for a loan. If you haven't checked your credit lately, it's a good idea to review your credit reports from the major credit bureaus. You can obtain free copies at AnnualCreditReport.com.
Reviewing your credit reports can give you an idea of the refinance rates for which you're likely to qualify. It's also an opportunity to check for errors so you can dispute them and possibly have them removed before you apply for a loan. The credit bureaus explain how to do that on their websites.
Your credit score is not part of your credit reports, although it is based on the information they contain. One or more of your credit card issuers may provide your credit score for free. Otherwise you can obtain free credit scores from a variety of other sources.
Decide what type of loan you want
Refinancing is an opportunity to change the terms of your mortgage. For example, if you currently have a 30-year loan, consider whether you want a new 30-year loan or possibly a 15- or 20-year one instead.
A loan with a shorter term will have higher monthly payments, but you'll pay less interest in total over the life of the loan and your mortgage will be fully paid off that much sooner.
Compare different lenders' rates and terms
Shopping around for the best mortgage refinance rates will likely save you money. For convenience, you might start with your current lender to see what kind of rates it is offering.
From there, you can expand your search to include other lenders, including online ones. In addition to their advertised interest rates, check on their:
- Minimum credit score and income requirements
- Loan-to-value ratio requirements (for cash-out refinance loans)
- Estimated time to close
- Closing costs
- Loan repayment terms
Apply for the new mortgage
When you've chosen the lender you want to do business with, you can start the application process.
Applying for refinancing may remind you of what you had to go through to get your earlier mortgage. So be prepared to share details about your income, assets, and debts. You may need to provide the lender with a stack of documents, such as bank statements, pay stubs, and statements from investment accounts.
It's also likely that you'll need to have your home appraised as part of the refinancing process. The appraisal helps the lender determine what the home is worth when underwriting a new loan. However, you may not need an appraisal for a government-backed loan, such as a Federal Housing Authority, Veterans Affairs, or U.S. Department of Agriculture loan.
Finalize your loan terms
At this stage, you should be close to sealing the deal on a new loan. Your lender may offer you the opportunity to lock your rate for a fee. This means your interest rate won't change before you close on the loan. Whether it makes financial sense to lock in your rate depends on what's happening with interest rates. If rates are volatile or appear poised to rise, paying for a rate lock could be worth it.
There are numerous mortgage refinance calculators online that can help you estimate the costs and potential savings of refinancing at various interest rates. Try a couple to make sure their results match.
The Bottom Line
Mortgage refinancing can be a good move if it allows you to save money, cash out some of your home equity, get more favorable loan terms, or pursue whatever your goals are. The steps involved aren't complicated but can be time-consuming. The most important thing may be to carefully compare mortgage rates and other terms so you can maximize your savings and make all the effort worthwhile.