Buying a home is a major milestone, but it’s not the end of the journey. You might decide to refinance your mortgage in a few years or even later. Here’s how to do that and what to expect.
What is mortgage refinancing?
Refinancing a mortgage means you get a new loan to replace the old home loan. You might want to refinance your mortgage if interest rates have dropped substantially since you signed your mortgage. You could potentially save a lot of money by refinancing to a new loan with a lower interest rate. You can check the latest rates for mortgage refinancing on Bankrate’s rate tool.
As a rule of thumb, it’s worth considering a refinance if you can lower your interest rate by about 1 percentage point or more. A mortgage refinance calculator can help you decide whether you’ll save enough money to make it worthwhile.
If you’ve been making regular payments on your mortgage for several years, you’ve likely build up some amount of home equity. Refinancing can be a way for you to take out some cash against that home equity, to fund home improvements or for any other purpose.
When should you refinance your mortgage?
Homeowners refinance their home loan for a variety of reasons:
- To get a lower interest rate. This usually means a lower monthly payment.
- To get a shorter term, so the mortgage will be paid off sooner. Example: replacing a 30-year mortgage with a 15-year loan.
- To get a lower interest rate and a shorter term.
- To switch from an adjustable-rate mortgage to a fixed-rate loan.
- To extract cash from the home’s equity. This is known as a cash-out refinance.
Benefits of refinancing your mortgage
Refinancing your mortgage can improve your finances in various ways:
- Free up money each month. If your refinanced mortgage has a lower monthly payment, you can put the saved funds toward other purposes, such as paying bills or simply paying down the principal faster.
- Pay off your house sooner. Refinancing from a conventional 30-year mortgage to a 15- or 20-year mortgage could help you become debt-free before retirement.
- Tap home equity to pay for renovation projects. If value of your home rises over time, you can access the home equity through a cash-out refi.
Risks and costs of refinancing a mortgage
Refinancing can be a mistake if you aren’t able to lower your interest rate much, or you incur a lot of fees.
- Refinancing isn’t free. Your refinanced mortgage comes with origination fees, an appraisal, title insurance, taxes and other costs, just like the original mortgage did.
Even if the refi results in a lower monthly payment, you won’t actually save money until the monthly savings offsets the cost of refinancing. You’ll need to do some math to figure out how many months it will take to reach this break-even point, which will help you decide whether it’s worthwhile.
- You may have a prepayment penalty. Ask your lender whether your original mortgage agreement includes any charges for paying off the loan early. Depending on the amount, 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, you’re likely going to pay significantly more interest and fees than if you’d kept the original mortgage. It’s typically wiser to refinance to a shorter term, with a lower interest rate.
No cash-out 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 ARM to a fixed-rate mortgage, that’s called a ‘no cash-out refinancing,’ or a ‘rate-and-term refinancing.’ For example, if you have an ARM that is set to adjust upward soon, and you refinance into a fixed-rate mortgage.
Rate-and-term refinancing pays off one loan with the proceeds from the new loan, using the same property as collateral. This type of loan allows you to take advantage of lower interest rates or shorten the term of your mortgage to build equity faster.
Example of a no cash-out refi (or rate-and-term refi)
Devyn gets a $100,000 mortgage with an interest rate of 5.5 percent. Three years later:
- Interest rates have fallen, and Devyn can refinance with an interest rate of 4 percent.
- After 36 timely payments, Devyn owes about $95,700.
In this situation, Devyn can save more than $100 a month by refinancing and starting over with a 30-year loan. Or Devyn can save less every month, while paying off the loan in 27 years — in other words, keeping the original loan’s payoff date.
|Loan amount||Interest rate||Loan term||Monthly principal and interest|
By contrast, cash-out refinancing leaves you with cash above the amount needed to pay off your existing mortgage, closing costs, points and any mortgage liens. You may use the cash for any purpose.
To be eligible for cash-out refinancing, you must have sufficient equity.
Market value – All mortgage debt = Equity
Kris and Avery bought a house four years ago. Today, it’s worth $200,000 and they owe $120,000 on the mortgage. Their equity is:
$200,000 market value
– $120,000 mortgage debt
= $80,000 equity
Example of a cash-out refi
Kris and Avery owe $120,000 on their mortgage and have $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 would pay off the $120,000 on the current loan and have $30,000 cash to pay for home improvements or other expenses. That would leave $50,000 in equity.
Once you’ve set a clear goal, you’re ready to shop lenders, compare refinance rates and get the ball rolling. You’ll also have plenty of paperwork to fill out and an appraisal to navigate.
Refinancing your home loan, step by step
Here’s a guide to help you get started.
- Set a clear financial goal. When considering a mortgage refinance, focus on lowering your monthly payments or interest rate without tacking on more years to repayment, if possible.
- Check your credit score and history. The higher your credit score, the better refinance rates lenders will offer you. Look for reporting errors and issues you can resolve to help boost your score.
- Determine how much equity you have. First, check your mortgage statement to see how much you owe on the balance. Next, check online home search sites to get a rough idea of your home’s value, or ask a real estate agent to run an analysis. In many cases, you can refinance a conventional loan with as little as 5 percent equity. If your equity is less than 20 percent, though, you’ll likely pay steeper rates and loan fees, plus private mortgage insurance.
- Shop multiple lenders. In addition to finding the best refinance rate, pay attention to other refinance fees. Find out whether those costs will be due upfront or rolled into your mortgage. Lenders sometimes offer “no-closing cost loans” but charge a higher interest rate or add to the loan balance. Once you choose a lender, discuss when it’s best to lock in your rate.
- Be transparent about your finances. Gather recent pay stubs, federal tax returns, bank statements and anything else your lender requests. Your credit and finances will be reviewed, too, so disclose all of your assets and liabilities upfront.
- Prepare for the appraisal. Some lenders may require an appraisal to determine the home’s current market value for a refinance approval. Let the lender know of any improvements or repairs you’ve done since buying your home that might add to its value.
- Come to closing with cash, if needed. The closing disclosure, as well as the loan estimate, will list cash needed to close. You might be able to finance those costs, but you’ll likely pay more for it through a higher rate or loan amount. Store copies of your closing paperwork in a safe location and find out how to make your new mortgage payments.
- Keep tabs on your loan. Your lender might resell your loan on the secondary market shortly after closing or years later. That means switching mortgage payments to a different company. Watch for mail from your lender notifying you of these changes.
Use a mortgage refinance calculator to learn how a mortgage refinance can work for you.
Learn more about today’s mortgage rates.
How does a mortgage refinance work?
A mortgage refinance is when you replace your current home loan with a new mortgage, usually to meet a specific financial goal. Refinances tend to close more quickly than new purchase loans, and you’re not limited to working with the same lender again. Once your refinance closes, the old loan is repaid in full and you’ll begin making payments on the new loan according to the terms you’ve agreed to.
Why should I refinance my mortgage?
The most common reasons to refinance your mortgage are to lower your monthly payments by reducing your rate or term, particularly if you bought your home when rates were higher. Homeowners also refinance to pay off their homes faster, eliminate private mortgage insurance or to take out cash from their built-up equity.
A home refinance isn’t exactly a cake walk. You have to get approved for a new loan, have your finances and credit vetted (again), get an appraisal and pay loan fees. It’s important to have a goal in mind when refinancing your mortgage. Let’s look at each reason you might refinance your home loan in greater detail.
Lower your monthly mortgage payments
Many people refinance their mortgage to lower their monthly payments. A rate and term refinance helps you do this by replacing your mortgage with a new loan sporting a lower interest rate, and for roughly the same term, or repayment period.
Tacking on another 30 years with a new loan when you are already years into an existing mortgage means you’ll pay more interest over time and it’ll take you longer to own your home free and clear. Depending on how much interest you’ve already paid, you may consider shortening the term or making extra mortgage payments to save on interest and repay the balance faster.
Pay off your home faster
Shorter-term loans tend to have lower interest rates because the lender risks its capital for a shorter time period. And the savings in interest payments could be substantial when comparing a 15-year fixed mortgage and a 30-year fixed mortgage. But there are drawbacks to a 15-year mortgage. More of your cash will be tied up in paying down your mortgage. That means you’ll have less money for expenses and to save for retirement, college or an emergency fund.
Eliminate private mortgage insurance (PMI)
When you first got your mortgage, you made a down payment of less than 20 percent, and you’ve been saddled with private mortgage insurance premiums, or PMI, as a result. But in the years since you got the mortgage, you paid down some of the loan balance and the value of your house rose. If the outstanding loan amount is less than 80 percent of the home’s appraised value, you might be able to refinance into a new loan and remove private mortgage insurance.
This could be a solid move if you have a loan insured by the Federal Housing Administration, or FHA. FHA loans have annual mortgage insurance premiums that cannot be canceled if you put down less than 10 percent — even when your loan-to-value ratio falls below 80 percent. The only ways to get rid of FHA mortgage insurance is to refinance the loan or sell the home.
Tap your home’s equity
Homeowners with sufficient equity in their homes sometimes turn to cash-out refinancing to meet a specific financial need. In a cash-out refi, you refinance your home loan into a new mortgage for a larger amount, and receive the difference in cash to use as you see fit.
There are responsible ways to use a cash-out refi. You can use the money to add value back into your home through a major remodeling project. You also can use it to pay off high-interest debt or for educational expenses. To do a cash-out refi, though, you typically need at least 20 percent equity in your home.
How to get the best mortgage refinance rate
Shop around with multiple lenders to get the best deals on interest rates and terms. Additionally, lenders generally offer the best deals to borrowers who have higher credit scores, a positive credit history, and a lower debt-to-income ratio.
As you shop, ideally you want to get a lower rate than what you currently have, but pay attention to the annual percentage rate, or APR. The APR gives you an overall picture of your total borrowing costs, including the loan’s interest rate, lender origination fees, points and other loan charges.
These details, along with your new monthly payments, will be spelled out in the loan estimate each lender gives you. This is a three-page document lenders must provide to you within three business days of receiving your refinance application. You can use the estimate and a refinance calculator to compare loan offers and identify the best deal.
Next steps to refinance your mortgage
Make sure to shop around for the best home refinance rates and terms. Refinancing makes sense if it puts your finances on a stronger footing, so weigh your decision carefully.
You can refer to Bankrate’s refinancing resources as you do your homework on the refinancing.
If you don’t qualify for a refinance or owe more than your home is worth, a government-backed mortgage program could provide some relief. Your lender might agree to modify your loan or find other solutions to make your monthly payments easier to manage if you face a financial hardship.