Have mortgage rates fallen since you purchased your home? Refinancing could make sense if you’re able to qualify for a lower interest rate. Ideally, homeowners should consider refinancing if they can shave one-half to three-quarters of a percentage point off a mortgage loan, says Greg McBride, CFA, chief financial analyst for Bankrate.
Even though mortgage rates have risen considerably in 2022 from their all-time lows, you still may be able lower your monthly payment and pay less interest over the loan term by refinancing. By one estimate at least 2 million homeowners can benefit from a refinance.
But before you apply for a new home loan, you should check your credit health, research loan options to determine which is best, and shop around to ensure you get the best deal on refinancing.
Also, consider signing up for a Bankrate account to determine the right time to strike on your mortgage with our daily rate trends.
Homeowners should consider refinancing if they can shave one-half to three-quarters of a percentage point off a mortgage loan, says Greg McBride, CFA, chief financial analyst for Bankrate.
1. Improve your credit score
Pay your bills on time. The largest component of a credit score is whether you pay your bills on time, so being consistent in this area is critical, says Greg McBride, CFA, chief financial analyst for Bankrate.
Pay down large credit card balances. Paying down a large credit card balance with a lump sum can help reduce your debt-to-available credit ratio. If possible, avoid using over 30 percent of your available credit on any one credit card.
Don’t close old accounts. Closing old accounts you’ve paid off lowers your amount of overall available credit and credit age.
Only apply for credit as needed. Each new credit inquiry drops your score by a few points and the impact is only temporary, but too many inquiries in a short period could hurt your credit score.
“There aren’t many ways to quickly improve your credit score,” says Jackie Boies, a senior director of housing and bankruptcy services for Money Management International, a Sugar Land, Texas-based nonprofit debt counseling organization. “Applying good credit practices over time is how you improve your score.”
2. Compare mortgage refinance rates
When looking to refinance and save, compare as many mortgage offers as possible. Even a fractional difference can save thousands.
When you compare interest rates, consider the APR, or annual percentage rate, as well, which encompasses annual fees and gives you a better idea of what the true cost is. You may find that the mortgage offer with the lowest advertised rate has higher fees and closing costs that don’t make the rate as attractive.
3. Buy points to lower your interest rate
Homeowners can buy points to lower their interest rate. In other words, you pay the lender upfront for a lower rate over the life of the loan. One “point” is equal to 1 percent of the loan amount.
Bruce McClary, spokesperson for the National Foundation for Credit Counseling, a Washington, D.C.-based nonprofit organization, says homeowners should negotiate the terms of the loan where they can. In addition, meeting all of the mortgage approval guidelines helps avoid having to pay more for what you borrow. This includes interest and prepaid points.
“Those with healthier credit scores have more negotiating power than those with average or low scores,” McClary says.
Getting more than one quote is also important. Lenders offer a variety of programs, ranging from “no points and out-of-pocket costs with a higher rate to those requiring more points upfront by permanently buying down the rate,” McBride says.
Homeowners short on cash should avoid depleting their reserves just to buy down the rate, however.
“Only do so if you can spare the cash and plan to be in the loan for a long enough time to reap the benefit of the lower rate,” McBride says.
4. Determine which loan term is best
While shorter loans such as a 10-year fixed or 15-year fixed carry lower rates than longer loans, the tradeoff is much higher payments — and that can be problematic if a job loss occurs.
“Homeowners shouldn’t stretch and saddle themselves to large payments that limit their flexibility just to save half a percentage point or so,” McBride says. “Maintaining financial flexibility is important.”
A longer mortgage term can help keep monthly payments low, but the loan will be costlier to repay because more interest is charged over time, McClary says.
5. Go for the fixed interest rate
The value for homeowners is in fixed rates when there is little difference between fixed rates and the initial rate on adjustable mortgages, McBride says.
“Go for the permanent payment affordability of the fixed-rate loan,” McBride says. A fixed rate can also help consumers budget more easily.
It makes sense to get a fixed-rate loan, for those who plan to remain in their home for longer periods of time, McClary says. “If it’s possible that rates could drop in the near future or the property could sell before the loan is repaid, a variable-rate loan could be the way to go.”
With a variable or adjustable-rate mortgage (ARM), the interest rate changes at predetermined intervals based on the market and a margin determined by the lender. So, while your interest rate can decrease at those times, it can also increase substantially — making a fixed-rate loan generally less risky.
6. Watch that loan amount
The more you borrow for a mortgage, the higher your monthly payment will be. A homeowner who gets a mortgage on a $250,000 home with a 4 percent interest rate for 30 years and a 10 percent down payment pays $1,195 a month, while a 20 percent down payment brings that down to $955, Boies says.
“You will want to consider the long-term savings over the life of the loan,” Boies says.
While it is easy to get confused when presented with all the options for refinancing a mortgage, there are many resources available for help.
“A HUD-approved nonprofit agency affiliated with the National Foundation for Credit Counseling can offer some expert advice and direction for making the right decision,” McClary says.
Borrowers need to fully understand the terms of their mortgage loan, as well. Utilize online calculators to help make decisions and find a mortgage that best suits your needs, Boies says.
7. Pay closing costs upfront
The amount of closing costs you’ll pay depends on the home’s purchase price and location, but it’s generally between 3 percent and 6 percent of the purchase price. So, if you want to refinance a $325,000 home loan, you’ll typically pay $9,750 to $19,500 in closing costs.
Some lenders offer to roll closing costs into the loan, but there’s a catch. You’ll likely have to pay a higher interest rate to secure a no-closing-cost refinance loan, which means your mortgage payment will be higher. Furthermore, you’ll pay the lender more in interest over the loan term.
To illustrate, the lender could offer to refinance your $325,000 home loan with a 30-year term at 4 percent APR, and $13,000 in closing costs. Or you could get a no-closing-cost refinance with the same loan term, but with a 4.5 percent APR.
If you go with the refinance that has the lower interest rate, you’ll pay $1,551.60 per month and $233,575.90 in interest for the duration of the loan. But if you opt for zero closing costs, your monthly mortgage payment will increase to $1,646.73, and you’ll pay a total of $267,821.81 interest.