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Mortgage rates have more than doubled in 2022, with the average APR on 30-year loans running near 7 percent. For most borrowers, that’s not the ideal climate for replacing a current loan with a new one.
Regardless, a refinance may be in your near future for many reasons. Here’s how the process works, the common options available to you, and what pros and cons to consider.
What is refinancing?
The term “refinance” is actually a bit misleading. When you refinance your mortgage, you’re not redoing it; you’re actually replacing your current mortgage with an entirely new loan. It could be with a different lender than the one you originally worked with to buy your home.
Refinancing has a lot of advantages: It can allow you to lower your monthly payment, save money on interest over the life of your loan, pay your mortgage off sooner and draw from your home’s equity if you need cash for any purpose.
How does refinancing a mortgage work?
The refinancing process is similar to your original mortgage application process. A lender will review your finances to assess your level of risk and determine your eligibility for the most favorable interest rate.
The new loan might have different terms — moving from a 30-year to a 15-year term or an adjustable rate to a fixed rate, for example — but the most common change is a lower interest rate.
Your new loan might also reset the repayment clock. Say you’ve made five years of payments on your current 30-year mortgage. That means you have 25 years left on the loan. If you refinance to a new 30-year loan, you’ll start over and have 30 years again to repay it. If you refinance to a new 20-year loan instead, you’ll pay your loan off five years earlier.
Refinancing comes with closing costs, which can affect whether getting a new mortgage makes financial sense for you. Before you refinance, it’s important to understand how long it will take for the costs of refinancing to pay off compared to how long you plan to stay in the home. You’ll also want to ensure you can afford the new payment and you’ll have enough equity remaining in your home.
How to find the best refinance rate
Shopping for a competitive refinance rate can save you money both upfront in closing costs and over time in monthly payments. Comparing rates and exploring the different options available to you are wise steps, as your refinanced mortgage will replace your existing loan.
Given how interest rates have spiked over the last year (and may continue into next year), you may also wish to explore a rate lock on your next mortgage. A rate lock is a guarantee that a mortgage lender will honor a specific interest rate at a specific cost for a set period. This protection can help to stabilize your monthly payment during volatile interest-rate times.
Four reasons to refinance
- You can get a lower interest rate. The biggest reason to refinance is the opportunity to lower your interest rate. Whether your credit has dramatically improved since you first secured your mortgage or the market has changed, access to a lower interest rate can save you loads of money over the course of the loan. That said, in today’s rate environment, you’re unlikely to save significantly unless you got your original mortgage at least 10 years ago.
- You can get a different kind of loan. Maybe you want to replace the uncertainty of an adjustable-rate mortgage with a fixed-rate mortgage, or maybe you’re hoping to stop paying FHA mortgage insurance by switching to a conventional loan. Refinancing gives you the chance to explore all the types of home loans to find an option that works better for your finances.
- You can use your equity to borrow more money. In addition to saving money, refinancing might be able to help you access more funds. Cash-out refinancing allows you to leverage the equity you’ve accumulated to borrow a bigger sum of money. While this adds to your debt, it can help you secure funding for big expenses — a home improvement project or college education, for example — at a relatively low interest rate.
- You can shorten your loan. If you currently have 20 years left on a 30-year mortgage, for instance, you might want to refinance into a 15-year loan for a long-term savings opportunity. Your monthly payments could go up, but you’ll pay off your home faster.
Pros and cons of refinancing a mortgage
Like most financial strategies, refinancing has both advantages and disadvantages.
- You could lower your interest rate.
- You could lower your mortgage payment and create more space in your monthly budget.
- You could decrease the term of your loan and pay it off sooner.
- You could tap into your home’s equity and take cash out at closing.
- You could consolidate debt — some homeowners use refinancing to put student loans or other debts into one simple payment.
- You could change from an adjustable-rate to a fixed-rate mortgage, or vice versa.
- You might be able to cancel private mortgage insurance premiums to avoid paying unnecessary fees.
- You’ll have to pay closing costs.
- You might have a longer loan term, adding to your costs and delaying your payoff date.
- You could have less equity in your home if you take cash out.
- You might need to deal with borrower’s remorse if rates drop substantially after you close.
- It’s not an overnight activity: The refinancing process can take between 15 and 45 days or more.
- Your credit score will temporarily take a hit.
Types of mortgage refinancing
There are many refinance options available for mortgage products, so you will want to evaluate the types of refinance available to you and consider each within the context of your unique financial situation. Your goal may be to adopt a shorter loan term, or maybe your focus is lower monthly payments. Explore the options available to decide which type of refinance best suits your objectives.
This is a basic form of refinancing that changes either the interest rate of the loan, the term (repayment length) of the loan or both. This can reduce your monthly payment or help you save money on interest. The amount you owe generally won’t change unless you roll some closing costs into the new loan.
When you do a cash-out refinance, you’re using your home to take cash out to spend. This increases your mortgage debt but gives you money that you can invest or use to fund a goal, like a home improvement project. You can also secure a new term and interest rate during a cash-out refinance.
With a cash-in refinance, you make a lump sum payment in order to reduce your loan-to-value (LTV) ratio, which cuts your overall debt burden, potentially lowers your monthly payment and also could help you qualify for a lower interest rate. Before making a cash-in refinance, you’ll want to evaluate whether paying the lump sum would deprive you of more lucrative opportunities or needlessly drain your savings.
A no-closing-cost refinance allows you to refinance without paying closing costs upfront; instead, you roll those expenses into the loan, which will mean a higher monthly payment and likely a higher interest rate. A no-closing-cost refinance makes most sense if you plan to stay in the home short-term.
If you’re struggling to make your mortgage payments and are at risk of foreclosure, your lender might offer you a new loan lower than the original amount borrowed and forgive the difference. While a short refinance spares the borrower the financial impacts of a foreclosure, this option comes at the expense of a hit to your credit score.
If you’re a homeowner aged 62 or older, you might be eligible for a reverse mortgage that allows you to withdraw your home’s equity and receive monthly payments from your lender. You can use these funds as retirement income, to pay medical bills or for any other goal. You won’t need to repay the lender until you leave the home, and while the income is tax-free, it’ll accrue interest.
Debt consolidation refinance
Similar to cash-out refinances, debt consolidation refinances give you cash with one key difference: You use the cash from the equity you’ve built in your home to repay other non-mortgage debt, like credit card balances. Your mortgage debt will increase, but you will be able to pay other debts down or off entirely. Plus, you might be able to take advantage of the mortgage interest deduction.
A streamline refinance accelerates the process for borrowers by eliminating some of the requirements of a typical refinance, such as a credit check or appraisal. This option is available for FHA, VA, USDA and Fannie Mae and Freddie Mac loans.
FAQs about refinancing
Refinancing a mortgage can have some impact on your credit, but it’s usually minimal. This can occur for multiple reasons:
- Mortgage lenders conduct a credit check to see if you qualify for a refinance, and this appears on your credit report. A single inquiry can shave up to five points off your score.
- If you plan to apply for other types of debt, such as a car loan or credit card, in addition to refinancing, your credit score can also be affected.
- When you refinance, you’re closing one loan and opening another. Your credit history makes up 15 percent of your score, so closing one loan and opening another has an impact.
In general, these effects will only be felt for a short period of time. If you’re concerned about hurting your score while comparing refinance offers, try to shop for loans within a 45-day window. Any credit pulls related to your refinance in this timeframe will only be counted as one inquiry.
Closing costs on a new loan can run between 2 and 5 percent of the amount you refinance. These line-items include discount points, your loan’s origination fee and an appraisal fee to evaluate your home’s worth. You’ll need to calculate the break-even point of all these expenses to determine whether you’ll stay in your home long enough to recoup them and benefit from the savings of the refinance.
Final word on mortgage refinance
Refinancing can be one of the most significant financial decisions you make. If you’re planning to remain in your home for years to come, extending your loan term to lower monthly payments — or using the equity you’ve built to finance home improvements — can make sound financial sense.
Of course, knowing when’s a good time to refinance your mortgage is key. It depends not only on your own current financial situation, but also on the general financial climate. When it’s volatile — as it has been in 2022, with interest rates rapidly climbing — you might want to hold off on a major move.
But that gives you more time to research the options and the lenders, to find the best refinance for you.