Refinancing Your Mortgage

Just because you take out a loan for 15 or 30 years doesn’t mean you are stuck with it the entire term. Many homeowners get a new mortgage to replace an existing home loan, called refinancing. In fact, the typical American homeowner with a mortgage refinances every four years, according to the Mortgage Bankers Association.

Borrowers refinance to get a loan that better meets their financial needs that have shifted over time or when mortgage or real estate market conditions change. The most common reason for refinancing is to get a lower interest rate. Refinancing a home loan with a lower mortgage rate can help you reduce your monthly payments and pay less interest over the life of the loan.

Here is an example of the difference in monthly payments for a homeowner with a $300,000 mortgage who refinances to a lower rate.

Rate Monthly Payment Total Payments Over 10 Years
Old Loan 5% $1,610 $193,200
New Loan 4% $1,432 $171,840
Difference 1% $178 $21,360

So why wouldn’t you refinance every time interest rates drop? There are costs involved, and if those costs can’t be recouped in a reasonable amount of time — before you sell the property or refinance again — it’s a money-losing proposition. The point at which the interest savings created by refinancing offset the upfront costs is called the breakeven point. A refinance calculator can help you determine your breakeven point.

Refinance Calculator

Use our Mortgage Refinance Calculator to compare lender offers, years to pay off your loan, and how much a small change in your interest rate may cost you over time.

Home CALCULATE

Note that sometimes the best refinance for you isn’t the one with the lowest interest rate. If you’re considering two refinance options, a loan with a higher rate but fewer costs (or even no costs) might be the smarter choice. And there are other reasons to refinance that don’t have to do with the interest rate.

5 Top Reasons to Refinance

Be Prepared for Rate Drops

It’s a mistake to wait until interest rates are in the news to start a refinance. Once it’s widely known that rates have fallen, refinance applications soar. Lenders have more business than they can handle, and that means refinancing a mortgage can take longer and cost more. Preparing ahead of time with two smart actions can keep you from missing out.

First, find your target rate. At what interest rate would it make sense for you to refinance? Take a look at current refinance rates, run the numbers through a refinance calculator, and see if the savings will outstrip the loan costs in a reasonable amount of time. If not, run the numbers again with a lower interest rate. Do this until the refinance would generate the needed savings — that’s your target rate or “trigger rate.”

Second, get preapproved for your refinance, which allows you to deal with an unexpected problems — such as a mistake on your credit report — without being under pressure to close before a rate lock expires. With a preapproval, as soon as rates drop into your strike zone, you can lock your loan and close your refinance quickly.

Refinancing Booms: How Homeowners Miss the Boat

Refinancing booms hit whenever mortgage rates drop significantly, falling below the trigger rate for many homeowners. This trigger rate is not the same for everyone — it’s the rate a homeowner decides is low enough to make refinancing worthwhile. There have been several refinance booms since the early 1990s.

In a 2012 Federal Reserve study, researchers concluded that many homeowners failed to capitalize on these refinance booms. Why? Some forgot to watch interest rates and missed their triggers. Others felt the savings were too good to be true, didn’t believe they qualified or simply found the paperwork too burdensome. The result proved costly: According to the Federal Reserve, among homeowners in 2013 who did not respond to refinance offers, the median savings passed up were $26,400 over the lifetime of the loan, or about $94 a month.

Refinancing: By the Numbers
1.2 percentage points

The average interest rate reduction for homeowners who refinanced at the start of 2015

The average first-year savings for a $200,000 loan refinanced at the start of 2015

$2,500

1 out of 5

Borrowers who could have qualified for and benefited from a refinance but did not go through with one, based on data from previous refinance booms

Sources: Freddie Mac, Federal Reserve

You may still be able to save even if you missed the last refinance boom — rates bounce up and down regularly, creating minibooms that can be taken advantage of if you’re prepared. If you did not refinance in 2015, check out a few mortgage rate quotes. To get accurate quotes, be prepared to provide your approximate credit score, home value and current home loan balance.

Spend a few minutes with our refinance calculator, and see how much you might save. Then, contact a couple of lenders with competitive quotes, and apply for mortgage approval. Most lenders underwrite refinance applications with automated underwriting systems (AUS), and it takes just a few minutes to get a preliminary approval, denial or request for more information.

The lender will tell you what documents are needed to complete your loan. Most common requirements include two years of W-2s and your two most recent paychecks (or two years of tax returns and a year-to-day profit and loss statement if self-employed), and copies of bank, retirement and investment account statements. Your lender will also pull a credit report and verify your debts and monthly payments.

Once you’re approved and rates drop into your target zone, you’ll lock your loan, your lender will order an appraisal and you’ll close your refinance. Applying and providing needed documents should not take long if you are organized — perhaps an hour or two. However, the savings can amount to thousands of dollars a year. How many opportunities do you get to earn thousands of dollars with a couple of hours of work?

Qualifying for a Refinance: Basic Requirements

One of the most common reasons homeowners did not refinance during previous housing booms, according to Federal Reserve researchers, was that they did not think they qualified for a new mortgage. Forty percent of borrowers who did not refinance could have benefited by doing so, and about half of those people would have qualified for better mortgage terms. That’s right — millions of people overpaid for their mortgages month after month, even though they would have qualified for substantial savings.

It’s understandable, however, that consumers don’t want to make the effort to apply only to be turned down. If you’re hesitant to put yourself out there because you’re worried about qualifying, run through this list of qualifications.

Credit Score & Refinance

Minimum credit qualifications include credit score thresholds and payment history requirements. Here are those of Fannie Mae and Freddie Mac, which back most conventional (non-government) loans today:

  • The minimum credit score is 620 unless applicants have no credit score.
  • There’s a two-year minimum waiting period for those who filed Chapter 13 bankruptcy, and there’s a four-year wait following a Chapter 7 bankruptcy. The Chapter 7 waiting period is two years for applicants who can document that their bankruptcies were caused by factors over which they had no control, such as the death of a wage earner.
  • Waiting periods following foreclosures, short sales and deeds-in-lieu of foreclosure range from two to four years, depending on the circumstances.
  • Mortgage payments more than 60-days late in the last 12 months are not acceptable.
  • Outstanding collections and judgments must be repaid at or before closing.

Homeowners with less than 20 percent home equity may also have to worry about the credit score minimums of private mortgage insurers. Those can be higher than minimums established by Fannie and Freddie.

Government-backed mortgages have less-stringent scoring guidelines. The U.S. Department of Veterans Affairs does not list a minimum credit score, and FHA minimum credit scores are 500 for a 90 percent loan and 580 for a 96.5 percent loan. However, while low credit scores can be acceptable, a poor payment history is not. Lenders will not approve loans to applicants who have established a pattern of missed or late payments despite having enough income to pay their bills on time. It takes at least a year or two of good payment history to re-establish credit in most cases.

Some mortgages are not backed by the government or sold to investors through Fannie Mae or Freddie Mac. Guidelines for these are set by individual lenders and can vary from those listed above.

Income & Mortgage Refinance

One of the biggest changes in mortgage reform is the ability to repay rule. The Consumer Financial Protection Bureau requires mortgage lenders to “make a reasonable, good faith determination of a consumer’s ability to repay any consumer credit transaction secured by a dwelling.” Mortgage lenders are presumed to have complied with this guideline if they limit the borrower’s debt-to-income ratio (DTI) to 43 percent or less.

Streamline Refinancing

The rules are a bit different for a streamline refinance. Streamline refinances involve replacing one government-backed loan with the same kind of loan — an FHA-to-FHA refinance, for example. Credit and income rules do not apply for streamline refinances because the government is already on the hook if the borrower defaults. Streamline refinancing can reduce the risk of default by improving the borrower’s financial position, so appraisals, credit scores, and income or employment verification may not be required. Similarly, borrowers who are eligible under the Home Affordable Refinance Program (HARP) may be able to refinance despite having negative equity, low credit scores or insufficient income.

When Refinancing Hurts You

Refinancing a mortgage can lower your monthly payment and reduce your interest rate. However, one downside of refinancing is that it restarts your loan term, and that can cost you more in the long run — even if you lower your interest rate. If you refinance a five-year-old 30-year mortgage with a new 30-year mortgage, your total repayment period becomes 35 years. Often, paying interest for an extra five years eats up much or all of the savings generated by a lower payment and interest rate. And what happens if you refinance again after five years? Your repayment will take a total of 40 years!

Extending the Life of the Loan

Misinformed loan officers and poorly designed refinance calculators ignore the fact that refinancing restarts the loan-repayment clock, which can cause borrowers to overestimate the benefits of a refinance. For example: Say you have a $300,000 mortgage with a 4.25 percent interest rate, so its balance after five years is $272,423. If you take that remaining balance and refinance it with a new 30-year loan at exactly the same rate, the new payment is $136 lower. Some lenders and calculators call this difference “savings,” yet there is clearly no saving here. In fact, even if there were no upfront costs with this refinance, it would still increase the borrower’s lifetime loan costs by $39,711 and add five years to the loan’s repayment period.

Check out what happens when you refinance a five-year-old loan to a lower rate without accounting for the extended repayment.

Original Loan
Beginning Balance $300,000
Rate 4.25%
Term (Years) 30
Monthly Payment $1,475.82
Total Interest Costs, First 5 Years $60,972
Ending Balance After 5 Years $272,423
5 years later No refinance
New 30-Year Loan
New 25-Year Loan
Beginning Balance $272,423 $272,423 $272,423
Rate 4.25% 3.75% 3.75%
Term (Years) Beginning Year 6 25 30 25
Monthly Payment $1,475.82 $1,261.63 $1,400.61
Lifetime Interest Costs $231,295 $242,737 $208,733
Lifetime Interest Savings from Refinancing none -$11,442 $22,562

When you refinance into a new 30-year mortgage, the loan will have a significantly lower rate and payment. However, by the time the new loan has been retired, you will have paid $11,442 more than if you did not refinance.

By making a higher payment and retiring the loan five years sooner with a 25-year mortgage, you turn $11,442 in additional costs into a $22,562 savings, while paying $75 less per month. This is a true savings because you did not extend the repayment term.

The No-Brainer Refinance

It’s always appropriate to refinance if you can reduce your interest rate at no cost or if you’ll recoup the refinancing fees before you sell your home. However, savings are guaranteed only if you avoid extending your repayment. By choosing a refinance with a shorter term or by paying a little extra toward your principal each month, you get the benefit of a lower interest rate without extending your repayment. (Your loan officer can tell you how much to pay, or you can work it out with a mortgage prepayment calculator.)

I Don’t Think I Qualify for a Refinance

Homeowners often hesitate applying for a refinance because they are afraid that they won’t qualify for a loan. Here are some borrowers who didn’t think they would get approved for a refinance but were able to overcome obstacles.

My Income Is Too Low to Refinance

I don’t think I can refinance,” said Jamey K. of Sacramento, California. “I’m retired and my income is much lower now — about half of what it used to be. I bought my house when I was working and I barely qualified then.”

Jamey had one more thing working against him — the Consumer Financial Protection Bureau and its Ability to Repay rule. Even borrowers who can afford a loan in real life might not get one if they can’t prove their income on paper. Fortunately, a couple of other rules worked in Jamey’s favor.

Jamey’s loan officer was able to increase his “paper” income two ways. First, she grossed up Jamey’s Social Security income. Because it’s not taxed, most underwriting guidelines allow lenders to increase untaxed income by 25 percent — so Jamey’s $3,000-a-month Social Security payment became $3,750.

In addition, new guidelines allowed Jamey’s lender to count his savings as income. This is called “asset depletion” and it works like this: underwriters take 70 percent of eligible assets and divide them by the number of months in the loan term. For a 30-year loan, that’s 360 months. Jamey had just over $700,000 invested, and 70 percent of that provided $490,000 in assets to deplete. Dividing $490,000 by 360 added $1,361 per month to Jamey’s income. Because he was able to increase “paper” income by $2,111 per month, Jamey got his refinance.

I Just Changed Jobs so I Can’t Refinance

Richard and Maria T. from Carson City, Nev., didn’t think they could refinance because of Richard’s new job. “I read that you have to be on your job for two years before you can get a mortgage,” Maria said. “And Richard just started this one two months ago.”

It’s a common misconception that borrowers need two years at their jobs to get a mortgage, probably because the Fannie Mae Form 1003 (mortgage application) requires applicants to provide a job history for the most recent two years. Self-employed and commissioned applicants do need at least two years history to demonstrate that their income is stable and continuous, and homeowners with bonuses or overtime must have at least a 12-month history to be able to count this income on their loan applications.

There is no minimum time requirement for the borrower’s current employment, however. In fact, Fannie Mae’s Selling Guide says, “Individuals who change jobs frequently, but who are nevertheless able to earn consistent and predictable income, are also considered to have a reliable flow of income for qualifying purposes.” Applicants can even get mortgages based on income described in a job-offer letter — before they’ve even started work!

What matters are these considerations:

  • Does the applicant’s work history indicate increasing responsibility and earnings?
  • Is the borrower financially strong despite frequent job changes?

Fannie Mae says, “If the job changes are for advancement or higher wages, these changes should be viewed favorably.” Someone whose two-year job history includes an internship, then a permanent job in the same field, then a similar job with better pay looks stable and successful. An applicant whose job history is short because he or she was in college or a job-training program can also be approved.

On the other hand, someone with a stint as an office manager followed by six months of working in a restaurant and then a winter spent as a ski instructor will probably have a harder time getting that income accepted. Fannie Mae’s Correspondent Lending Guidelines say, “Evaluation of history of employment, ability to generate similar income consistently, number of years in the same field of work, specific educational background and sources of any additional compensation must indicate the income can be expected to continue.”

Bottom line? Richard’s new job was in the same field and came with a higher salary than the old one. He and Maria had no problem refinancing to a better loan.

Home Equity & Mortgage Refinance

Most mortgage refinance programs require home equity. Home equity is the difference between the appraised value of a property and the amount of loans against it.

Home Equity Example
Home Appraisal Value $200,000
Mortgage Balance $150,000
Resulting Equity $50,000

In the above example, we start with the appraised value ($200,000) then subtract the home loan balance ($150,000) to arrive at the owner’s equity ($50,000).

Another way of referring to home equity is loan-to-value (LTV). The LTV is 100 percent minus the percentage of home equity. In the example above, the homeowner has 25 percent home equity, and 100 percent minus 25 percent equals a 75 percent LTV.

How to Calculate Your LTV

To calculate your LTV, simply divide the refinance loan amount by your home’s estimated value. Let’s use the numbers from our example.

Calculating Loan-to-Value
Home Appraisal Value $200,000
Mortgage Balance $150,000
150,000 / 200,000= 75% LTV

When looking for mortgage rate quotes from lenders, you’ll need to provide them with a reasonably accurate estimate of your home’s value. If you claim that your property is worth $200,000, and then the appraisal comes in with a value of $180,000, your LTV will be higher. This could increase your mortgage rate or even cause your loan to be declined.

Home Appraisal for a Refi

Your lender orders a home appraisal to get an independent estimate of the property value. The appraiser analyzes the following:

Prices of nearby recently sold property

The supply of and demand for homes

The average time properties are on the market before being sold

Trends — are prices increasing or decreasing?

The home’s condition compared to nearby homes

The home’s features and improvements

The size of the home and its lot

Zoning

Hazards or conditions that affect the home’s livability and marketability

If you have your home appraised by several professionals, chances are their estimates won’t be the same. Although appraisals are conducted according to a set of rules, they’re still opinions and, by definition, somewhat subjective. In addition, some lenders rely on automated valuation models (AVMs). These tools look at recent sales prices nearby; no one actually views the house. AVMs are fast and cheap but software doesn’t know if you spent $100,000 remodeling your place and adding to its value. This means your home appraisal might not come in as high as you expect, and that can affect your refinance.

How to Avoid a Low Appraisal When Refinancing

There are steps you can take to get an accurate but generous appraisal. First, make sure your home looks inviting when the appraiser comes — trim the yard, clear the clutter and make sure everything is clean and smells good. Next, provide an accurate set of your home’s plans and a list of any improvements and their costs.

Inaccuracies in property records can cause errors on appraisals, as can measurement mistakes. According to the National Association of Realtors, errors are most commonly caused by incorrect lot or floor plan dimensions, or by undervaluing improvements.

However, inaccurate data aren’t the only reason your appraisal might come in lower than expected. Thanks to a reform called the Home Valuation Code of Conduct (HVCC), lenders can’t choose who performs their appraisals, and appraisers sometimes grab jobs they’re not best-qualified to take. A 2014 Federal Reserve study concluded: “The HVCC leads to a significant increase in the likelihood of low appraisals.”

You can avoid getting stuck with inexperienced or out-of-area appraisers by checking up on them when they call to schedule your appraisal. Get their names and look them up online to see where their office is and how long they have been licensed. You can do that by searching on this national appraiser registry. If the appraiser’s office is not located near your property or the appraiser has not been licensed in your state for very long, that’s probably your cue to ask for another appraiser.

How to Dispute a Low Appraisal When Refinancing

If your appraisal comes in low, you may be able to get it changed if you can find an objective error — the wrong square footage or sales price, for example. However, subjective differences of opinion (“My view is worth way more than that!”) are unlikely to result in a changed valuation.

There are right and wrong ways to dispute with your appraiser, and the wrong way won’t help much. Try this form, which was created by an appraiser and can be downloaded by anyone who wants to request a revision. The idea is to up your chances of getting a higher value by making the revision process easy for the appraiser — appraisers work under very tight time constraints and don’t always appreciate being asked to revisit a file. Forward the completed form to your loan officer, who can in turn pass it to the appraisal or underwriting department for review.

Another solution, if you can afford it, might be to simply order and pay for a second appraisal. Not all lenders allow you to substitute a better second appraisal for a low first appraisal, but many do. When your loan officer gives you the bad news about your home value, tell him not to submit the appraisal for underwriting. Request a new one, and make sure you vet the appraiser first so you don’t get another “low-baller.” If the new appraisal comes in higher, that one can be used for your refinance. If it doesn’t, you may have to live with the fact that your property is worth less than you thought.

Finally, if you are very sure that your property is worth more than the appraised value, you can start the application process over with a different lender and appraisal service.

Can You Refinance With Bad Credit?

Refinancing is not impossible with bad credit. Loan approval depends on the entire application package. Refinance underwriters evaluate an applicant’s credit, income, home equity and assets. A low credit score can be offset by substantial equity, excellent income or significant assets.

However, it’s harder to get a loan approval with bad credit than it used to be. Most programs have minimum credit scores, and individual lenders often go beyond that, adding tougher restrictions called overlays. The best advice for homeowners with bad credit is to work to improve their scores and shop multiple mortgage lenders. Even a few points can be the difference between denial and approval.

Average Refinance Score

Source: Ellie Mae

In general, government-backed loans such as FHA, VA and USDA are a bit more forgiving than conventional programs. Homeowners with credit problems should consider an FHA streamline refinance if their current loan is government-backed. Streamline programs don’t require credit underwriting.

Refinancing an Underwater Mortgage

5.1 Million Underwater Home Loans

Source: CoreLogic data, 2014

If you are underwater on your loan, with a mortgage balance that’s greater than your property value, HARP might make refinancing possible. To qualify for the program:

  • Your loan must have closed before May 31, 2009
  • The loan must be owned by Fannie Mae or Freddie Mac.
  • Your mortgage must be current
  • Your loan payment history should not reflect any missed payments in the previous 12 months and no late payments in the last six months.

Even if you’re not underwater, a HARP refinance might be your best bet. Suppose that you originally financed your home purchase with an 80 percent home loan, and mortgage insurance was not required. However, if your home lost value, a new refinance might end up being 90 percent of your home’s value, which would require mortgage insurance. The HARP program does not require the addition of mortgage insurance if your original loan did not have it. You can be eligible for HARP if your loan-to-value (LTV) exceeds 80 percent.

Read this HARP page to learn more about this program.

Other Reasons to Refinance

Sometimes people refinance for reasons other than finding a lower interest rate. One common reason is if a couple splits and both names are on the home loan. Another reason is to get rid of mortgage insurance.

Ditch Your Spouse, Keep Your House

When a couple divorces and one keeps the home, both parties who signed the loan are still obligated by the mortgage on the property — even if the divorce decree orders a former spouse to make the payments. The order from a family law judge does not dissolve or alter a home loan contract. The easiest option to resolve a joint home loan is to refinance in the name of the occupying spouse.

FHA Streamline Loans & Divorce

Homeowners with FHA loans may be in luck. The FHA streamline program allows a spouse to be dropped from the loan if the property transfer occurred more than six months previously and the remaining owner-occupant can demonstrate he or she made the mortgage payments during this time. In other words, if you make your payments on your own for six months, you may qualify for an FHA refinance.

Conventional Loans & Divorce

Borrowers with conventional loans must qualify to refinance, and prove they earn enough income to make the house payment and take care of their other obligations.

What If You or Your Ex-Spouse Cannot Refinance?

Some recently divorced individuals do not qualify for a refinance. There may not be enough equity in the property, or the homeowner’s income or credit score might not meet a lending requirements.

Limited Good Options

You do have a few options if you or your ex-spouse cannot afford to refinance. One is to ask the nonoccupying ex-spouse to agree to extend the refinance deadline. Put this change in writing, and file it with the court. Or, ask the lender if it will allow an assumption. However, it is under no obligation to do so unless assumptions were written into the original contract. Finally, you can sell the house.

Contingency Plan in the Divorce Decree

Talk to your lawyer about including a contingency in the divorce decree in case one spouse can’t refinance. This can eliminate a second trip to court and allows the couple to implement a plan B, which may involve selling the property or changing the distribution of assets.

Refinance to Eliminate Mortgage Insurance

Refinancing a mortgage can help you get rid of private mortgage insurance (PMI) sooner. You can request PMI cancellation as soon as your loan balance hits 80 percent of the original home value (when the loan was closed), and PMI is automatically canceled once your loan hits 78 percent of the original balance.

However, if your home’s value has increased to the point that PMI isn’t required, you don’t benefit unless you refinance. For example, if you buy a $300,000 home financing 95 percent ($285,000) with a 4 percent interest rate, it would take 55 payments before you could request PMI cancellation. If your home appreciates at 4 percent per year, however, you could dump your mortgage insurance by refinancing after just 34 payments. That means you could avoid 21 mortgage insurance payments, which might cover the cost of refinancing.

If you have a newer FHA mortgage, your mortgage insurance cannot be canceled — no matter how much your home’s value increases or how low your loan balance is. That’s because FHA loans now require mortgage insurance premiums (MIP) for the life of the loan. The only way to get rid of MIP is to refinance to a conventional loan.

Updated: July 27, 2017