What is mortgage refinancing?
Mortgage refinancing is when you replace your current home loan with a new one. Just like any other loan, you apply for refinancing
, which includes a thorough check of your credit, income, employment history and finances. A lender orders a home appraisal
to assess the current market value of your home, too, to evaluate how much equity
you have in it.
When you refinance, the borrowed money from your new loan pays off your existing loan. Most people refinance to lock in a lower interest rate
and lower their monthly payment, or to shorten the term of their mortgage. You can also get a cash-out refinance
, which allows you to borrow against the equity in your home, pulling some portion of the difference between what you still owe and its current value. Many lenders cap cash-out refinancing at 80 percent of the home’s total value on most loan types. Ideally, you’ll also get a lower rate in the process. The money you tap from your home’s equity can be used to consolidate higher-interest debt or to improve your home.
How much does it cost to refinance a mortgage?
While refinancing can save you money in the long run, it comes with upfront fees
. Refinancing usually includes the same fees you paid when you first bought your home, such as:
- Lender fees, including a mortgage application fee, loan origination charges and points
- Third-party fees, such as the appraisal fee, document recording and a credit check
- Title search/insurance fees
- Escrow costs for property taxes and homeowners insurance
Your closing costs
will vary depending on the new loan amount, your credit score and debt-to-income ratio, loan program and interest rate.
Shopping around for a lender who not only offers a competitive interest rate but also the lowest fees is worth your time and effort. Because refinancing
can cost thousands of dollars, make sure refinancing has a tangible financial benefit to you and that you’ll stay in your home long enough to recoup the fees.
What is the break-even point on a mortgage refinance, and why does it matter?
A key consideration when deciding whether to refinance a mortgage
is when you’ll break even on your costs. The break-even point is calculated by adding up all refinancing closing costs and figuring out how many years it will take you to make up those costs with the savings from your new mortgage payment compared to your previous one. Refinancing makes more sense if you plan to stay in your home longer than the break-even point, otherwise, you could potentially lose money.
How long do you plan to stay in your home, and why is it important?
Before refinancing, you should first consider how long you plan to stay in your home. Refinancing if you plan to move in a few years doesn’t always make financial sense even if you get a lower interest rate, because you may not have enough time to break even on closing costs
. Most experts say you’ll want to be in your house at least two to five years after refinancing, but you should do your own break-even calculation to figure out what makes the most sense for you.
What are the most common reasons to refinance a mortgage?
Homeowners refinance their mortgage for a variety of reasons. No matter what your motivation is for refinancing, the result should leave you better off financially. Here are a few common reasons why homeowners decide to refinance a mortgage:
- To lock in a lower interest rate and lower their monthly payments. Homeowners who have improved their credit score or lowered their debt-to-income ratio, for example, might be eligible for a better rate today if they refinance.
- To switch from an adjustable-rate mortgage, or ARM, to a fixed-rate loan. Borrowers who took out an ARM but plan to stay in their homes may want to refinance into a more stable, fixed-rate loan before the ARM resets to a variable rate and payments become unaffordable, or at least less predictable.
- To pull out cash from their home’s equity. A cash-out refinance lets you tap your home’s equity by replacing your existing mortgage with a new one for a larger loan amount, taking the difference in cash.
- To remove a borrower from the mortgage. Divorce is another reason to refinance in order to get your former spouse’s name off the loan. This might also apply if you bought a home with another relative or friend. The person who is refinancing the loan into his or her name will have to qualify for the new loan solely with their own income, credit and employment. Don’t forget that removing someone from a mortgage doesn’t remove them from the deed of the home, which may require filing a legal document called a quitclaim deed (check your state’s property laws for guidance).
- To get rid of FHA mortgage insurance. For borrowers with a loan insured by the Federal Housing Administration, known as FHA loans, refinancing into a conventional mortgage can eliminate annual mortgage premium payments once you’ve reached 20 percent equity in your home.
Refinancing next steps
If you’ve looked at the numbers and decided that refinancing makes sense, then it’s time to shop around for a refinance lender. Check with your current mortgage servicer, as well as national banks, credit unions, online mortgage lenders and possibly a mortgage broker to compare refinance rates
Make sure you get everything in writing, such as fees and interest rates. Lenders will send you a loan estimate that breaks down your new loan details and all fees. Loan estimates are great tools for comparison shopping to give you the clearest picture of which lender will help you meet your refinance goals.
Where do I find more information on mortgage refinancing?
Visit our refinance resource page
for calculators, tools and articles to help guide you on your mortgage refinance journey. Whatever your goals are, the Mortgage Refinance Calculator on this page can help you do some initial legwork to see if refinancing will save you money. Once you’re ready to take the next steps, it’s time to shop lenders.