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There are many reasons for refinancing your current mortgage. Switching from an adjustable rate to a fixed rate or taking out a longer-term loan are two common ones. Tapping the equity in your home for some extra funds is another. And let’s not forget the most popular of all: scoring a better interest rate.
Let’s explore when, why and how to refinance a mortgage — in a handy step-by-step guide.
What is mortgage refinancing?
But first, a quick primer. A mortgage refinance means you get a new home loan to replace your existing one. If you can refinance into a loan with a lower interest rate than you’re currently paying, you save money on your monthly payment and the interest you pay over the loan term.
A certain type, the cash-out refinance, essentially acts as a lower-interest loan. You get ready money — up to the amount of your actual equity (ownership) stake in the house,
As a rule of thumb, it’s worth considering a refinance if you can lower your interest rate by at least half a percentage point and you’re planning to stay in your home for at least a few years.
How to refinance your mortgage
- Set a clear financial goal
- Check your credit score and history
- Determine how much home equity you have
- Shop multiple lenders
- Get your paperwork in order
- Prepare for your home appraisal
- Come to closing with cash if needed
- Keep tabs on your loan
Step 1: Set a clear financial goal
There should be a good reason why you’re refinancing — whether it’s to reduce your monthly payment, shorten the term of your loan or pull out equity for home repairs or debt repayment.
What to consider: If you’re reducing your interest rate but restarting the clock on a 30-year mortgage, you may pay less every month, but you will pay more over the life of your loan. That’s because most of your interest charges occur in the early years of a mortgage.
Step 2: Check your credit score and history
You’ll need to qualify for a refinance just as you needed to get approval for your original home loan. The higher your credit score, the better refinance rates lenders will offer you — and the better your chances of underwriters approving your loan. For a conventional refinance you will need a credit score of 620 or higher to be approved; in some cases, lenders will accept 580 for an FHA or VA refi mortgage. They won’t let you borrow as much, though.
Step 3: Determine how much home equity you have
Your home equity is the total value of your home minus what you owe on your mortgage. To figure it out, check your mortgage statement to see your current balance. Then, check online home search sites or get a real estate agent to estimate your home’s current fair market value. Your home equity is the difference between the two. For example, if you still owe $250,000 on your home, and it is worth $325,000, your home equity is $75,000.
What to consider: You may be able to refinance a conventional loan with as little as a 5 percent equity sake, but you’ll get better rates and fewer fees (and won’t have to pay for private mortgage insurance or PMI) if you have at least 20 percent equity. The more equity you have in your home, the less risky the loan is to the lender.
Step 4: Shop multiple mortgage lenders
Getting quotes from at least three mortgage lenders can save you thousands. Once you’ve chosen a lender, discuss when it’s best to lock in your rate so you won’t have to worry about rates climbing before your loan closes.
What to consider: In addition to comparing interest rates, pay attention to the various loan fees and whether they’ll be due upfront or rolled into your new mortgage. Lenders sometimes offer no-closing-cost refinances but charge a higher interest rate or add to the loan balance to compensate.
Bankrate’s refinance rate table allows you to comparison-shop loans, to help you find the best fit for your financial needs.
Step 5: Get your paperwork in order
Gather recent pay stubs, federal tax returns, bank/brokerage statements and anything else your mortgage lender requests. Your lender will also look at your credit and net worth, so disclose all your assets and liabilities upfront.
What to consider: Having your documentation ready before starting the refinancing process can make it go more smoothly and often more quickly.
Step 6: Prepare for the home appraisal
Mortgage lenders typically require a home appraisal (similar to the one done when you bought your house) to determine its current market value. An outside appraiser will evaluate your home based on specific criteria and comparisons to the value of similar homes recently sold in your neighborhood.
What to consider: You’ll pay a few hundred dollars for the appraisal. Letting the lender or appraiser know of any improvements, additions or major repairs you’ve made since purchasing your home could lead to a higher appraisal.
Step 7: Come to the closing with cash, if needed
The closing disclosure, as well as the loan estimate, will list how the extra expense in closing costs to finalize the loan. You may need to pay 3 to 5 percent of your total loan at closing. What to consider: You might be able to finance the costs, which can amount to a few thousand dollars, amortizing them over the course of your loan. But you will likely pay more for it through a higher interest rate or total loan amount, which amounts to more interest in the long run. (And yes, they’ll probably slap you with a fee to do it, too.) It often makes more financial sense to pay upfront if you can afford to.
Step 8: Keep tabs on your loan
Store copies of your closing paperwork in a safe location and set up automatic payments to make sure you stay current on your mortgage. Some banks will also give you a lower rate if you sign up for autopay. What to consider: Your lender or servicer might resell your loan on the secondary market either immediately after closing or years later. That means you’ll owe mortgage payments to a different company, so keep an eye out for mail notifying you of such changes. The terms themselves shouldn’t change, though.
Reasons you should refinance your home loan
When the costs of refinancing can be recouped in a reasonable period, it might make financial sense to do, depending on your goals. These could include:
- To reduce your monthly mortgage payment. Securing a lower interest rate can lower your mortgage payments by hundreds of dollars.
- To pay your mortgage off sooner. If you convert a 30-year mortgage into a 15-year one, you can pay it off faster and reduce the total amount of interest you owe.
- To make your mortgage payment more manageable. Taking out a 30-year mortgage to replace a 15-year mortgage can help reduce your monthly payment.
- To switch from an adjustable-rate mortgage (ARM) to a fixed-rate loan. This is smart if you think rates will go up in the future or if you just want a predictable monthly payment
- To take advantage of your home equity. After you pay off your original mortgage, any money left over can be earmarked for home renovation projects, debt consolidation or paying large expenses, like college tuition bills.
- To eliminate mortgage insurance. This applies mainly to FHA loans that financed more than 90 percent of the original home purchase. Their mortgage insurance premiums can only be canceled if you refinance the loan, swapping it out for a new non-FHA one. However, the new lender will have wanted you to have built up at least 20 percent equity in your home.
A refinance calculator can crunch the numbers and determine how much you can afford to refinance.
Benefits of refinancing your mortgage
- Free up money each month — If interest rates have fallen since you first got your mortgage, a rate-and-term refinance can replace your loan with a new one that has a lower rate, meaning you pay less to your lender each month.
- Pay your home off faster — If you got your mortgage some time ago and never refinanced, refinancing to a new loan with a shorter term and a lower interest rate could substantially reduce interest payments. One word of caution: if you’re putting more cash into paying off your mortgage each month, you could have less money on hand for expenses or savings.
- Eliminate mortgage insurance — If rising home values and loan payments have pushed your home equity above 20 percent, you might be able to refinance into a new conventional loan without private mortgage insurance (PMI). (Depending on your loan terms, your lender could remove PMI as soon as you meet the 20 percent equity threshold without needing to refinance.)
- Change your FHA loan into a non-FHA loan — If you have an FHA loan and put down less than 10 percent, the only way to remove the mortgage insurance is by refinancing to a non-FHA loan. Even with today’s higher interest rates, this move could save you money overall.
- Tap your home’s equity — If you have over 20 percent equity in your home, you could turn to cash-out refinancing. By refinancing your home loan into a new mortgage for a more significant amount, you could receive the difference in ready money to spend however you like. Cash-out refinancing makes sense if you use the money to invest back into your home through a major remodeling project or pay off high-interest debt.
- Lock in a fixed-rate mortgage — If you’re in an adjustable-rate mortgage (ARM) that’s about to reset and you believe interest rates will rise, you can refinance into a fixed-rate loan. Your new rate might be higher than what you’re paying now, but you’re guaranteed it won’t rise in the future.
Considerations before refinancing your mortgage
- Refinancing isn’t free — Just like your original mortgage, your refinanced mortgage comes with costs, such as an origination fee, an appraisal, title insurance, taxes and other fees. You only save money until the monthly savings offset the cost of refinancing. You’ll need to do some math (use this calculator) to figure out how many months it will take to reach this break-even point. If there’s a chance you’re going to move before then, refinancing is probably not the best move.
- You might have a prepayment penalty — Some mortgage lenders charge you extra for paying off your loan early. A high prepayment penalty could tip the balance in favor of sticking with your original mortgage.
- Your total financing costs can increase — If you refinance to a new 30-year mortgage and you’re well into paying off your initial 30-year loan, you’re going to pay more in interest than if you’d kept the original mortgage since you’re extending the loan repayment time.
Rate-and-term refinance vs cash-out refinance: What’s the difference?
When you refinance in order to reset your interest rate or term, or to switch, say, from an adjustable-rate (ARM) to a fixed-rate mortgage, that’s called a rate-and-term refinance.
Rate-and-term refinancing pays off one loan with the proceeds from the new loan, using the same property as collateral. This allows you to lower your interest rate or shorten the term of your mortgage to build equity more quickly.
By contrast, cash-out refinancing leaves you with more cash than you need to pay off your existing mortgage, closing costs, points and any mortgage liens. You can use the cash for any purpose. To be eligible for cash-out refinancing, you typically need to have substantially more than 20 percent equity in your home.
Example of a rate-and-term refinance
Jessica gets a $100,000 mortgage with an interest rate of 5.5 percent. Three years later, Jessica has a much better credit score and can refinance to an interest rate of 4 percent. After 36 on-time payments, she still owes about $95,700. In this situation, Jessica can save more than $100 per month by refinancing and starting over with a 30-year loan — or, she can save $85 per month while keeping the loan’s original payoff date, paying it off in 27 years, and also reducing the total cost of the loan by about $8,000. Better still, in terms of saving on interest, would be to refi into a 15-year loan. The monthly payments will be higher, but the interest savings are massive.
Example of a cash-out refinance
Christopher and André owe $120,000 on a mortgage on a home that’s worth $200,000. That means they have 40 percent, or $80,000, in equity. With a cash-out refinance, they could refinance for more than the $120,000 they owe. For example, they could refinance for $150,000. With that, they could pay off the $120,000 on the current loan and have $30,000 cash to pay for home improvement and other expenses. That would leave them with $50,000, or 25 percent equity.
Next steps: How to get the best refinance rate
Once you’ve determined why you want to refinance and the type of loan you want, you’re ready to shop lenders and compare refinance rates. Get quotes from at least three sources, including a mortgage broker, a bank and an online lender. Be sure to compare their rates as well as fees and other charges that could add to the overall cost of the loan.