Mortgage refinancing is when you take out a new home loan to pay off an existing mortgage. If you refinance, you may be able to lock in a lower interest rate, reduce your monthly payments, pay off your mortgage faster or even tap into your home’s equity.
The mortgage refinancing process may be more straightforward than when you initially borrowed a loan to buy your home, but there are still a number of factors you should consider before applying. Here’s everything you need to know about how mortgage refinancing works, from comparing interest rates to closing on your new loan.
[Read: Best Mortgage Refinance Lenders.]
How to Refinance a Mortgage in 7 Steps
Step 1: Determine Your Reason for Refinancing
Before you start reaching out to lenders, first ask yourself why you want to refinance. Once you’ve set a tangible goal, you can tailor the mortgage refinancing process from there.
One of the most common reasons to refinance a mortgage is to change the repayment terms, such as interest rate or loan length. This is called a rate-and-term refinance. By lowering your mortgage rate, you may be able to reduce your monthly payments and save money on interest charges over the life of the loan. And shortening your repayment period — for example, going from a 30-year loan term to a 15-year loan term — can help you pay off your home loan faster.
Additionally, a rate-and-term refinance can help you switch from an adjustable-rate mortgage, or ARM, to a fixed-rate mortgage. You might also consider refinancing to get rid of private mortgage insurance once you’ve gained 20% equity in your home or to add a co-borrower such as a spouse.
Another option is a cash-out mortgage refinance, which allows you to tap into your home’s equity by taking out a mortgage loan that’s worth more than what you currently owe on your home. You receive the difference in a lump sum payout after closing, which you can use as you see fit.
Step 2: Gather Financial Information
— What are your current repayment terms? You’ll need to know the details of your existing mortgage, including the interest rate, remaining loan balance and monthly payments. That way, you can determine your desired repayment terms based on your existing loan.
— What credit score is needed to refinance? A good rule of thumb is to have a credit score of at least 620 to meet the eligibility requirements for mortgage refinancing. Additionally, you should maintain a debt-to-income ratio of 43% or lower to be considered by qualified lenders, the Consumer Financial Protection Bureau says.
— How much equity do you need to refinance? You’ll generally need at least 20% equity in your home to refinance without paying private mortgage insurance. Still, you may be able to get a lower rate without that much equity, so it’s important to compare offers from lenders.
— How much does it cost to refinance a mortgage? Similarly to when you purchased your home, you’ll pay closing costs when you refinance. Mortgage refinancing closing costs are about 2% to 5% of the total loan amount, which includes the loan application fee, appraisal fee and title search fee, as well as other expenses. The average closing costs for mortgage refinancing are approximately $5,000, according to Freddie Mac.
Step 3: Shop Around to Compare Mortgage Rates
Most lenders let you see your estimated mortgage refinance rate through a process known as preapproval, which doesn’t require a firm commitment on your end.
Get preapproved through at least three lenders to find the most competitive repayment terms for your financial situation. You should also get a rate quote from your current mortgage lender, so you can see if it will match or beat your other offers. Freddie Mac research shows that comparing just one additional rate quote could save you an average of $1,500 over the duration of the loan.
It’s important to note that getting a mortgage preapproval results in a hard credit inquiry, which will impact your credit score. You should aim to complete all your preapprovals within a 14-day period to minimize the impact to your credit score, since multiple inquiries made during this window count as a single inquiry.
[Compare: Mortgage and Refinance Rates in Your Area.]
Step 4: Choose the Right Offer for Your Goals
With multiple loan estimates in hand, you’re ready to compare your options. If you’re looking for the cheapest option in the long run, it’s important to consider the annual percentage rate, or APR, instead of just the interest rate. The APR is an annualized measure of the total cost of the loan, which includes interest, discount points, closing costs and other loan fees. And if you’re looking for the lowest possible monthly payment, be sure to read the loan agreement to see how this option would impact your long-term interest costs.
Since you’ll be partnered with your new mortgage lender for up to 30 years, you may also want to compare lender reviews. Keep an eye on customer satisfaction, outstanding complaints and ease of application.
Step 5: Formally Apply Through the Lender of Your Choice
Once you’ve chosen a loan offer, you’ll begin the mortgage refinancing application. This process takes between 30 and 45 days from start to finish, although the timeline may vary based on the loan type.
Mortgage lenders need to get a clear picture of your financial situation to ensure you can repay the loan. You’ll be expected to provide identification and proof of income with pay stubs, bank statements and W-2s.
At this point, you’ll be given the chance to lock in your mortgage rate. Rate lock periods typically last from 15 to 60 days or more, with longer rate locks being more expensive. You may also opt to pay for a rate lock extension if your loan is taking longer to close than expected.
Alternatively, some lenders may let you bypass the rate lock, or “float” your rate. And in some cases, you may be offered a float-down option, which gives you the ability to lower your rate if the market rate drops during closing.
[Read: Best Mortgage Lenders.]
Step 6: Get Your Home Ready for the Appraisal
Just like during the homebuying process, you’ll need to have your home appraised when you refinance. A home appraisal gives you — and your lender — an estimate of your property’s value, which will be compared with your loan amount.
Before the appraiser visits your property, make a list of any upgrades you’ve made while you’ve owned the home. You may also want to complete any outstanding home repairs that would otherwise lower the value of your property.
If your home appraises at or above the loan amount, then your lender will continue the underwriting process. But if the appraised value comes in lower, you may need to reduce the loan amount or dispute the appraisal report through your lender.
Step 7: Close on Your New Mortgage
During the closing process, you (and everyone else on the loan) will meet with a representative from your title company or the lender. You’ll go over the closing disclosure, which details the final numbers like your interest rate and monthly payment, and sign the loan documents.
The mortgage refinancing lender will then use the funds to repay your previous lender, which means you’ll be responsible only for your new loan. If you’re doing a cash-out refinance, then the difference between your loan funds will be issued to you after closing.
When Should You Decide to Refinance Your Mortgage?
— You can qualify for a lower mortgage rate than you’re currently paying. One of the greatest advantages of refinancing is the cost savings, since you’re aiming to lower your mortgage rate. But if you already locked in a record-low rate during 2020 or 2021, then current mortgage rates may not be favorable enough to justify a refinance.
— You plan to remain in your home long enough to offset closing costs. Because closing costs for mortgage refinancing can be up to 5% of the total loan amount, you’ll want to make sure you’re still saving money over the life of the loan. If you plan to sell your house in just a few years, the interest savings may not outweigh the closing costs.
— You want to tap into your home’s equity to meet another financial goal. Cash-out mortgage refinancing can be an effective way to finance home repairs, pay off credit card debt or cover college expenses, especially if you’re sitting on a mountain of equity. But be careful not to borrow more than you can repay, as this can drive up your mortgage payments and overall interest charges.
— You can afford to pay off your mortgage faster. Shortening your repayment period from 30 years to 15 years can help you get a lower mortgage rate and save you money over time. However, this will typically result in higher monthly payments. You can use a mortgage refinance calculator like this one to make sure you can afford your new payments.
Benefits of Mortgage Refinancing
— Interest savings. If you can qualify for a lower mortgage rate than what you’re paying on your existing loan, refinancing can save you a significant amount of money on interest charges over the life of the loan. It can also help you lower your mortgage payments without extending your loan term.
— Lower monthly payments. In addition to the cost savings of a lower interest rate, refinancing can potentially help you reduce your payments even further by eliminating private mortgage insurance, or PMI. If your home has risen in value since you bought it, you may meet the loan-to-value requirement needed to remove PMI.
— Accelerated payoff. By refinancing to a shorter repayment period, you can get out of mortgage debt years faster. This will typically raise your monthly payment, but it could translate to substantial savings over the life of the loan.
— Fixed rates. Mortgage refinancing allows you to switch from an adjustable-rate mortgage to a fixed-rate mortgage. If you have an ARM that’s nearing the end of the adjustment period, you may want to lock in a fixed rate to reduce the risk of long-term rate hikes.
— Access to equity. Cash-out refinancing lets you tap into your home’s equity, which can free up a significant amount of money that you can use to meet other financial goals. You can potentially reinvest your equity into your home through renovations that can further add to your property’s value.
Drawbacks of Mortgage Refinancing
— Closing costs. Even if you qualify for a lower mortgage rate, your savings may be offset by closing costs when you refinance. For example, if you pay $6,000 in closing costs and fees, you may need to remain in your home for several years to make refinancing worthwhile.
— Slower repayment. If you refinance an existing 30-year mortgage into a new 30-year loan, you’re effectively restarting the clock on your mortgage debt. This means you’ll end up making more payments over time and adding to your overall interest costs.
— More debt. In the case of cash-out refinancing, you’re taking on a larger mortgage than what you currently owe. This adds to the overall cost of borrowing, since you’ll be paying interest on a higher loan amount.
— Prepayment penalties. Some (but not all) lenders charge a prepayment penalty if you pay off your mortgage early. Take a look into your current loan disclosure to see if your lender charges this fee.
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Update 06/03/22: The story was previously published at an earlier date and has been updated with new information.