Key takeaways
- Refinancing replaces your current mortgage with a new one, adjusting the rate, term or both.
- With refinancing, you can change the loan type as well as your lender.
- To refinance a mortgage, you'll pay between 2 and 5 percent of the loan amount in closing costs, so if you're refinancing to save money, you'll need to calculate your break-even point.
Mortgage rates more than doubled last year and have remained stubbornly higher in 2023. For most borrowers, that’s not the ideal climate for replacing a current loan with a new one. Regardless, a refinance might be in your near future for many reasons. Here’s how refinancing a mortgage works, the common options available to you and 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. You could refinance with your current lender or work with a different lender completely.
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.
Refinancing also comes with closing costs, which can affect your decision. Consider how long it will take for the refinancing costs to pay off compared to how long you plan to stay in the home, and whether you can afford the new payment. If you’re taking cash out, consider, as well, whether you’ll still have enough equity remaining in your home. Brush up on these common mortgage refinance myths to help you decide what makes financial sense for you.
How does refinancing work?
When you refinance your home, you’ll apply in a similar way to when you applied to purchase your home. In many ways, the process is like a less strenuous version of getting a purchase mortgage. In general, you’ll submit to a credit check, turn in financial documentation, submit to an appraisal and undergo the underwriting process. Typically, refinancing a mortgage takes as long as purchasing a home, averaging between 30 and 45 days.
Types of mortgage refinance
There are many types of refinancing, so consider each within the context of your unique financial situation. Your goal might be to adopt a shorter loan term, or maybe your focus is to lower monthly payments. Here’s a breakdown of each.
This form of refinancing changes either the loan’s interest rate, the loan’s term (repayment length) or both.
When you do a cash-out refinance, you’re using your home equity 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.
With a cash-in refinance, you make a lump sum payment 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.
A no-closing-cost refinance is a type of low-cost refinance that allows you to refinance without paying closing costs upfront; instead, you roll those expenses into the loan, which means a higher monthly payment and likely a higher interest rate.
If you’re struggling to make your mortgage payments and are at risk of foreclosure, your lender might offer you a short refinance, where your new loan is lower than the original amount borrowed, and forgive the difference.
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.
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.
A streamline refinance accelerates the process for borrowers by eliminating some refinance requirements, such as a credit check or appraisal. It’s available for FHA, VA, USDA and Fannie Mae and Freddie Mac loans.
Reasons to refinance your mortgage
- You can get a lower 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 home loan types 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 help you access more funds. Cash-out refinancing allows you to leverage the equity you’ve accumulated to borrow more 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 — typically at a lower interest rate compared to credit cards or other loans.
- 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.
How to refinance your mortgage
What happens when you refinance your home or rental property? The refinancing process is similar to the purchase mortgage application process: The lender reviews your finances to assess your risk level and determine your eligibility. Here’s what you can expect:
- Set a clear financial goal
- Check your credit score and history
- Determine how much home equity you have
- Shop multiple mortgage lenders
- Get your paperwork in order
- Prepare for the home appraisal
- Come to the 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 a mortgage, whether it’s to reduce your monthly payment, shorten your loan term 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 might pay less every month, but you’ll pay more over the life of your loan in interest.
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 offer you — and the better your chances of underwriters approving your loan. For a conventional refinance, you’ll need a credit score of 620 or higher to be approved.
What to consider: While there are ways to refinance your mortgage with bad credit, spend a few months boosting your credit score, if you can, before you contact lenders for rates.
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 latest mortgage statement to see your current balance. Then, check home search sites or have a professional appraisal to estimate your home’s value. Your home equity is the difference between the two. For example, if you still owe $250,000 on your home, and it’s worth $325,000, your home equity is $75,000.
What to consider: You’ll get better rates and fewer fees (and won’t have to pay for private mortgage insurance) if you have at least 20 percent equity in your home. 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 help you maximize your savings when you refinance a mortgage. 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 refinance 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 to compensate.
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 score and net worth, so disclose all your assets and liabilities upfront.
What to consider: Having your documentation ready before refinancing a mortgage can make the process go more smoothly and often faster.
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. A professional 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. Let the lender or appraiser know of improvements, additions or major repairs you’ve made since purchasing your home; this could lead to a higher refinance appraisal.
Step 7: Come to the closing with cash, if needed
The closing disclosure, as well as the loan estimate, list the closing costs to finalize the loan.
What to consider: You might be able to finance the costs, which can amount to a few thousand dollars, but you will likely pay more for it through a higher interest rate or total loan amount. Do the math for yourself, but know that it often makes more financial sense to pay closing costs upfront if you can afford to.
Step 8: Keep tabs on your loan
Some lenders give you a lower rate if you sign up for autopay. Store copies of your closing paperwork in a safe place.
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 loan terms themselves shouldn’t change, though.
Pros and cons of mortgage refinance
Pros of mortgage refinance
- You could lower your interest rate.
- You could lower your mortgage payment and create more space in your monthly budget.
- You could decrease your loan's term 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 refinance a mortgage to put student loans or other debts into one payment.
- You could change from an adjustable-rate to a fixed-rate mortgage.
- You might be able to cancel private mortgage insurance premiums to avoid paying unnecessary fees.
- You likely won’t need to make another down payment.
Cons of mortgage refinance
- 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.
- Most refinances won’t affect your property taxes, but completing a remodel with a cash-out refinance can increase your home's value — which could mean a higher tax bill.
- If you’ve paid off a significant chunk of your mortgage, refinancing might not make sense.
Mortgage refinance FAQ
Closing costs on a mortgage refinance 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.
Shopping for a competitive refinance rate can save you money upfront in closing costs and over time in monthly payments. Since your refinanced mortgage replaces your current loan, it’s a good idea to compare rates from at least three lenders and explore your options.
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 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.
You might be able to access equity in your home without refinancing your mortgage. Consider a home equity loan or a home equity line of credit (HELOC) as alternative ways of reaching your financial goals.
A second mortgage and a refinance are not the same thing. A refinance replaces your current mortgage with a new one, and you’ll only have one payment at one interest rate. A second mortgage — also known as a home equity loan — takes out a second lien on the home. With a home equity loan, you’ll keep your original mortgage payment and add a second monthly payment for repaying your home equity.
You can reduce your monthly mortgage payment by recasting your mortgage. With a mortgage recast, you’ll make a large lump sum payment toward the principal balance of your mortgage. Your lender will then reamortize your loan, taking into account the new principal balance and lowering your monthly payment.
The time you have to let your mortgage season before refinancing depends on the loan type and the mortgage investor. FHA loans require you to wait six months, for example. Besides time, another limiting factor when refinancing a mortgage is equity. In general, you’ll need at least 20 percent equity before refinancing.
Deciding if a mortgage refinance is right for you
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. You can even refinance multiple times, as long as you abide by your lender’s waiting period (if they have one).
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 since 2022, with interest rates moving up — you might want to hold off on a major move.
As an expert in the field of mortgage finance and refinancing, let me delve into the key concepts discussed in the article, providing comprehensive insights and shedding light on the intricacies of mortgage refinancing.
Refinancing Overview: Refinancing is a financial strategy that involves replacing an existing mortgage with a new one, allowing adjustments to the interest rate, loan term, or both. The primary reasons for refinancing include lowering monthly payments, saving on interest over the loan's life, paying off the mortgage sooner, or accessing home equity for various financial needs.
Types of Mortgage Refinance:
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Rate and Term Refinance:
- Changes either the loan's interest rate, term, or both.
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Cash-Out Refinance:
- Utilizes home equity to receive a cash sum, increasing the mortgage debt.
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Cash-In Refinance:
- Involves making a lump sum payment to reduce the loan-to-value ratio, potentially lowering monthly payments and interest rates.
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No-Closing-Cost Refinance:
- Allows refinancing without upfront closing costs by rolling them into the loan, leading to higher monthly payments.
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Short Refinance:
- Offered to homeowners at risk of foreclosure, where the new loan is lower than the original borrowed amount.
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Reverse Mortgage:
- Available for homeowners aged 62 or older, allowing withdrawal of home equity with monthly payments.
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Debt Consolidation Refinance:
- Uses home equity to repay non-mortgage debts, such as credit card balances.
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Streamline Refinance:
- Accelerates the process by eliminating certain requirements, available for specific loan types.
Reasons to Refinance:
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Lower Interest Rate:
- Access to a lower interest rate can result in significant long-term savings.
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Change in Loan Type:
- Switching from adjustable-rate to fixed-rate mortgages or transitioning between different loan types.
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Access to Home Equity:
- Cash-out refinancing allows leveraging accumulated home equity for major expenses.
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Shorten Loan Term:
- Refinancing to a shorter term can lead to long-term savings, despite potential higher monthly payments.
How to Refinance:
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Set a Clear Financial Goal:
- Identify the purpose of refinancing, such as lowering payments or accessing home equity.
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Check Credit Score:
- A higher credit score improves refinance rates; a score of 620 or higher is typically required for conventional refinancing.
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Determine Home Equity:
- Calculate home equity by subtracting the mortgage balance from the home's estimated value.
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Shop Multiple Lenders:
- Obtain quotes from at least three lenders to find the best rates and terms.
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Get Paperwork in Order:
- Prepare financial documentation, such as pay stubs and tax returns, to streamline the application process.
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Home Appraisal:
- A professional appraisal determines the current market value of the home.
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Closing with Cash:
- Be prepared to cover closing costs, either upfront or by rolling them into the loan.
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Monitor Loan:
- Stay informed about the loan terms and any potential changes, as lenders may sell the loan on the secondary market.
Pros and Cons of Mortgage Refinance: Pros:
- Lowering interest rates and monthly payments.
- Access to home equity for various financial needs.
- Consolidation of debts into a single mortgage payment.
- Opportunity to change from adjustable-rate to fixed-rate mortgages.
Cons:
- Incurring closing costs.
- Potential extension of loan term.
- Reduction in home equity if cash-out refinancing is chosen.
- Possible borrower's remorse if rates drop substantially after refinancing.
Mortgage Refinance FAQs:
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Closing Costs:
- Typically range between 2 and 5 percent of the refinanced amount, including items like discount points and appraisal fees.
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Shopping for Rates:
- Comparing rates from multiple lenders can save money upfront in closing costs and over time in monthly payments.
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Credit Impact:
- Refinancing may have a minimal impact on credit scores, mainly due to credit checks during the application process.
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Accessing Equity without Refinancing:
- Home equity loans or lines of credit provide alternative methods to access equity without refinancing.
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Second Mortgage vs. Refinance:
- A refinance replaces the existing mortgage, while a second mortgage (home equity loan) adds a new lien on the property.
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Mortgage Recasting:
- Making a lump sum payment toward the principal balance can lead to reamortization, reducing monthly payments.
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Timing for Refinancing:
- The ideal time to refinance depends on the individual's financial situation and the overall economic climate, considering interest rate trends.
In conclusion, navigating the landscape of mortgage refinancing requires a thorough understanding of the various types, considerations, and potential impacts on personal finances. Whether driven by the desire to save money, access equity, or change loan terms, individuals should carefully assess their goals and the prevailing economic conditions before deciding to refinance.
