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If you’re a homeowner, you might wonder if refinancing is a good idea right now, given the way interest rates have doubled or even tripled of late. Well, yes. Despite rising rates, refinancing still may make sense for some borrowers.
If you’re a first-time refinancer, there are usually surprises in store, such as closing costs, credit checks and resetting your payment timeline. Here we help take the mystery out of refinancing and dispel a few abiding myths.
Myth 1: Refinancing is cost-free
Homeowners usually hear a lot about how much they can save by refinancing their mortgage, but they rarely hear about the closing costs associated with doing so.
These fees can amount to as much as 2 to 5 percent of the principal of an existing mortgage. For example, if your fees are 3 percent on a $250,000 mortgage, then your upfront payment is $7,500. Many lenders will allow you to roll those costs into your new loan, but that will increase the principal you must repay.
Myth 2: The interest rate is the most important factor
For many homeowners, the name of the game is to get the lowest interest rate possible to maximize savings. However, the term of the loan is another factor borrowers should consider before refinancing — because it can impact how much they actually save.
When you refinance to a loan with the same term, you reset the payment clock, explains Michele Sine, portfolio manager and senior wealth adviser at ImpactAdvisor. For instance, homeowners who have been paying on their 30-year mortgage for 10 years, go back to zero when they refinance to another 30-year loan. This added time (that’s 120 additional monthly payments) costs money as the initial payments mostly cover interest to the service provider.
“It’s an uneven playing field when it comes to payments. In short, the bank always wins, because they get their money first,” Sine says.
Homeowners who are keen on saving money over the life of their loan can either refinance into a lower-rate and shorter-term loan (such as going from a 30-year fixed-rate mortgage to a 15-year fixed-rate mortgage) or make extra monthly payments to repay the loan faster.
Myth 3: A refinance will affect selling the house
Refinancing your mortgage doesn’t put an additional lien on your home. It just swaps out the primary lien on the home with a new one. This means that the refinance doesn’t have an impact on any home sale or dirty your title in any way. (Though they are technically claims on the property, mortgages aren’t as negative as other sorts of liens, because they don’t involve any dispute, and it’s assumed they’ll be settled with any sale proceeds.)
The confusion often arises because of home equity loans (aka second mortgages) and HELOCs, other types of debt that use your house as collateral. People who have a primary mortgage often take these out when they need funding for something — particularly home improvements or repairs. In those cases, it’s true you wouldn’t be able to sell the home until you paid back those loans — or immediately paid them at the closing, out of the sale proceeds.
But refinancing is strictly based on your ability to pay back the loan as evidenced by your credit and employment history. That means it wouldn’t impose any restrictions on future sales, any more than your original mortgage did.
Myth 4: You won’t need a credit check
It might come as a surprise that lenders require a credit check for refinancing a home loan. After all, you’ve been repaying the loan on time, so why should lenders want to recheck your credit? But to them it’s a new loan, so they must vet the borrower for the current state of their finances. However, borrowers with an excellent credit profile are rewarded with the lowest interest rates.
“Generally, homeowners with credit scores over 760 will qualify for the best refinancing rates,” says Leslie Tayne, founder and head attorney at Tayne Law Group in New York’s Westchester County. “And lenders will likely be looking for your debt-to-income ratio to be less than 36 percent to ensure that you’re not carrying too much debt and can adequately pay back the loan. Some homeowners may be surprised to find out they don’t qualify.”
So, before you apply for refinancing, check your credit score and DTI ratio. Since the objective of refinancing is to get the best rate, then you’ll want to make sure your financial picture is good enough to get it, or at least cut your current rate significantly.
Myth 5: You can only refinance your mortgage once
There’s no limit to how often you can refinance your mortgage. However, the fees are substantial, so it pays to ensure each refinancing makes sense. Use a refinance calculator to see if this is a route you want to take, particularly if you refinanced your home loan in the past few years.
“In reality, you can refinance your mortgage as many times as you want, but many lenders look for a ‘seasoning’ period, or an amount of time in between refinances before they’re comfortable approving another,” Tayne says. “Additionally, the prepayment penalty could come into play here, as well. If you have a prepayment penalty on your loan, you could be charged if you attempt to refinance again” (or refinance within a certain time period).
Keep in mind: Few mortgages come with prepayment penalties these days, but it pays to ask about this and other gotchas before you settle on a refinance lender.
Bottom line on refi myths
Though interest rates are higher than they have been in recent years, and you have to pay closing costs, there remain some reasons to think about refinancing. Extending your term could lower your monthly payment. Shortening it could save you money overall. But crunch the numbers and be sure the savings is worth the time, effort and short-term expense. And don’t forget to shop around, getting quotes from at least three lenders, to find the best rate and terms.
Additional reporting by T.J. Porter