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In today’s low-interest environment, refinancing a mortgage can not only save you money but also potentially help homeowners access the money they have built up in their homes. Before going through the process, it’s important to understand how it works, how your credit affects your rate and what you can do to get the best possible outcome.

Key Takeaways

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A mortgage refinance can help lower your monthly payments or unlock the cash in your home to consolidate debt, start a remodeling project or take a dream vacation.

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Some of the cons include high out-of-pocket fees, closing costs, pushing your break-even point further away or potentially going underwater from taking too big of a loan.

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Before you start on a mortgage refinance, set a goal for your refinance, understand your credit and talk to multiple lenders to get the best possible rate.

What Is a Mortgage Refinance?

A mortgage refinance is the act of rolling over your current mortgage into a new home loan. During this process, your home loan provider will assess your home’s current market value, go through your credit and tax return history and verify your credit. If everything is successful, your home mortgage lender will present you with several options to lower your monthly payment, take equity out on your home or reduce the number of years on your home loan.

Refinance Savings for a $300,000 Mortgage
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Why Should You Refinance Your Mortgage?

There are several reasons why homeowners consider refinancing their mortgage. The biggest reason is to save money on their monthly payment. You can do this through a refinance by moving to a lower interest rate or by eliminating your private mortgage insurance (PMI) payment from the loan amount.

Another reason to consider a mortgage refinance is to unlock some of the equity you have built into your home. You can use the money to pay off high-interest debt — like credit cards or personal loans — or invest it back into your home through remodeling projects.

Refinancing can also help you reduce the amount of time you will be paying your home loan. By shaving years off your mortgage, you can unlock more equity faster or walk away with more money if you decide to sell your home.

If you are curious about how you could save money, a mortgage refinance calculator can help you compare the costs and benefits of refinancing.

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Completing a mortgage refinance at a lower rate can help you reduce your monthly payment. Refinancing from a 6% interest rate to a 3% interest rate can put over $4,000 back in your pocket every year.

Benefits of Refinancing Your Mortgage

There are numerous benefits to refinancing your mortgage. While most of them revolve around reducing your monthly payment, a new mortgage can have a shorter term, stabilize your payment with a fixed interest rate or help you use the equity you have built up in your home. These are the most common reasons homeowners decide to refinance:

  • Reduce your payment through lower interest: If your current interest rate is higher than today’s rates, you could save money through refinancing. For example: Refinancing a $250,000 mortgage to lower the interest rate from 6% to 3% would save over $400 per month on interest and principal payments alone.
  • Reduce your payment by eliminating PMI: Purchasing your home with less than a 20% down payment means you will probably pay private mortgage insurance (PMI) on top of your principal and interest. Refinancing once you have 20% equity built-in can cut out the PMI payment, unlocking even more savings every month.
  • Shorten your mortgage length: If you are considering selling your home or want to get out from under monthly payments, shortening your mortgage length can help you get the most from your home. Converting from a 30-year mortgage to a 15-year home loan helps you build your equity faster, resulting in more options for your home.
  • Converting to a fixed rate: While adjustable-rate mortgages (ARM) are great for the initial term of 3–5 years, the monthly payment can spike once it’s over. Refinancing an ARM can put you on a fixed rate for 10, 15 or 30 years. This means you’ll know what your monthly payment is every month, allowing you to build a balanced budget for your home.
  • Take cash out from home equity: Are you considering remodeling your home, paying off high-interest credit cards or going on vacation? Your home can help you get the money you need to achieve those goals. If you have over 20% equity in your home, you can use a cash-out refinance to borrow against your equity to cut down on bills, invest in the value of your home or go on that once-in-a-lifetime trip.

In most cases, homeowners can refinance their homes at any time to take advantage of savings or draw some of the equity for other use. Before signing any papers and making it official, it’s critical to understand all the costs of refinancing. These include going over your credit profile, understanding your credit score, finding the refinance quote that reflects your best options and determining how much you will pay in upfront costs.

Costs of Refinancing Your Mortgage

While several positives come with refinancing your mortgage, it also comes with some costs which need to be considered. Closing payments, prepayment penalties and a longer break-even point can all outweigh the potential benefits of taking out a new mortgage.

  • New closing costs and fees: Before you can finalize your new loan, you will be responsible for paying for several refinancing costs. This includes closing costs and fees for items like home inspections. Even though you can add some of them to the loan, it will affect your monthly payment and could erode your savings.
  • A lower rate could have higher fees: Getting the lowest interest rate often requires paying “points” towards your loan. This means you will need to pay cash out of your pocket to lock in your loan.
  • Prepayment penalties: Some mortgages may have prepayment penalties, meaning you’ll pay more if you decide to reduce your balance early. Be sure to understand the terms and conditions before closing.
  • Longer break-even point: Extending the life of your home mortgage by several years could put your break-even point further out in the future, depending on how long you intend to live in your home. It’s important to use a refinance calculator to understand your total savings and when you can actualize them.
  • Underwater loans: If you take out too much money, you run the risk of having a mortgage that is more than your home is worth. Known as “going underwater,” it’s important to understand the actual market value of your home before signing loan documents.

How to Refinance Your Mortgage

Refinancing a mortgage shouldn’t be a quick decision. After weighing the pros and cons, you can determine your goals and take the necessary steps toward lowering your payment or taking cash out to achieve your financial goals.

1

Set a Goal for Your Mortgage Refinance

Before starting toward refinancing, it’s important to set a goal for starting a new mortgage. Are you interested in saving money on your monthly payment? Or is taking out cash to consolidate debt or fund a big project more important? By setting a clear-cut goal, you can decide the best way to move forward with a refinance.

2

Check Your Credit Score

As with any transaction involving credit, you should know your credit score before talking to lenders. Checking your credit report can help you understand how lenders perceive your risk, and it allows you to fix any erroneous information before requesting rates. Although you can refinance with bad credit, you may not qualify for the best rates.

3

Shop for Mortgage Refinance Rates With Multiple Lenders

Once you understand your credit, you can now shop for mortgage refinance rates with several lenders to see which gives you the best options. You can request multiple quotes from lenders within 14 days of your first request without negatively impacting your credit. If you qualify for a VA mortgage refinance or FHA mortgage refinance, you will want to work with lenders who can help you explore those options.

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Select a Mortgage Refinance Lender and Lock Your Refinance Rate

Once you’re satisfied that you’ve found the best option, it’s time to “lock” your rate with the lender. It’s important to lock as soon as you’ve made your decision because mortgage rates change daily, and each day you don’t lock could mean a higher rate. Some lenders will allow you to “float down” if there’s a lower interest rate after you close, but it may come with an additional fee.

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Prepare to Close Your Refinanced Loan

Once you’ve locked, your lender will start the closing process. Just like with purchasing your home, you will have to go through all the paperwork, including income verification and submitting tax return information. Depending on the specifics of your refinance, you may also need to have your house appraised, which can cost upwards of $400.

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Attend the Mortgage Refinance Closing

At the final step, you can sign your closing paperwork and take full advantage of your refinance. Just like your first closing, your lender will tell you where to go and what you will need to provide. Be prepared with a government-issued photo ID and the cash required to close. You can also wire transfer the cash to the bank in advance.

Expert Insight on Mortgage Refinancing

To help answer all your questions, MoneyGeek spoke with industry leaders on refinancing and home lending. This panel will help you identify what to look for, when you should consider refinancing and how to avoid scams in the process.

  1. Why is the current market ideal for homeowners to consider a mortgage refinance?

    Refinance activity continues to be strong as mortgage rates are hovering into record lows. Specifically, the 30-year fixed-rate mortgage is currently more than 100 basis points lower than a year earlier and nearly 200 basis points lower than two years ago. So, assuming that they bought their home last year, their monthly mortgage payment drops roughly by $140 for a 30-year fixed-rate mortgage.

    Respectively, their monthly mortgage payment is $250 lower from a 200-basis-point drop of the mortgage rates (assuming a 30-year fixed mortgage rate with a 10% down payment for a typical home). So, yes, now is a very good time to refinance. However, you shouldn’t feel rushed. Expect rates to hike no higher than 3.1% in 2021. This is still a significantly lower rate than a year and two years ago.

    Mortgage rates are at historic lows this year, with underwriting remaining at pre-pandemic standards, many times with allowances for effects from COVID-19 over the past nine months. This means that the current market is ideal for refinancing an existing mortgage because it is very likely that the borrower will be able to find a better rate on their mortgage or find an alternative amortization schedule to meet their financial goals.

    With this extraordinary rate environment, the availability of low financing rates is causing a surge in applications for refinancing, which also means that borrowers should shop around until they find the best rate available for them, while also inquiring as to the duration of time required to refinance with that particular lender. Some lenders may hold off on providing the best rates if they are at their capacity or will add fees and possibly increase rates to slow volume.

  2. What questions do homeowners need to consider before refinancing?

    Before refinancing, they should first check if they would qualify for a refinance — for instance, to compute the amount of equity that they have in their home. To do so, they need to compare what their home is worth with the amount that they still owe on the mortgage. Remember that homeowners need to have at least 20% equity in their home to qualify for a new loan without PMI.

    The good news is that home prices continue to rise due to the housing shortage. Nationwide, the value of the typical home has actually increased continuously since February 2012 on a year-over-year basis. Moreover, they should check their credit score. A higher credit score will help them get a better interest rate. For instance, if they have a credit score below 700, they may need to try to increase it before they refinance.

    Also, they should have in mind that there are additional costs associated with refinancing, such as closing costs. A new 0.5% “adverse market fee” is also in effect starting this month. This applies to refinance loans over $125,000 that are backed by Fannie Mae and Freddie Mac. Thus, they should compare all these additional costs with the savings from the lower mortgage payment to see if it makes sense for them to refinance.

    Just because rates are low doesn't mean that homeowners should rush into a new refinancing arrangement. It's important for them to carefully consider all of their financial options and to ensure that the choice to refinance actually provides them with a financial advantage. It's also important to be completely confident that they are securing the best rate that is available to them based on their financial position and credit history.

    Additionally, homeowners should carefully inspect all of the details of any new refinancing deal, as well as consider if their financial position has changed since they first signed a mortgage loan. Is it a fixed or variable rate? What are the terms of their current mortgage? How much equity do they have in their home? Has their credit score improved? How does this help reach their financial goals?

  3. What should homeowners look for when comparing refinance offers?

    Many homeowners may try refinancing with their current mortgage lender. However, that lender may not offer the best option. Thus, it’s a good idea to look for other offers. Then, they should compare the interest rates and terms of each lender’s offer. They should also compare the fees listed. Remember that they can always negotiate with the lenders.

    The most important step in selecting the right refinancing offer is to do a side-by-side comparison with all of their offers and be entirely confident that they understand every element of the deal. It's also important to compare every new refinancing offer to the details of the original mortgage to ensure that there is a clear benefit to refinancing.

    For anyone who has any doubt during this process, it's always important to consult a mortgage expert who can help guide the homeowners toward the best financial decision. Be aware that their compensation arrangement may not match your needs, so finding an unbiased expert will avoid some industry pitfalls.

  4. How can homeowners protect themselves from refinance scams?

    Homeowners must remain vigilant and be cautious of offers that sound too good to be true. Especially, they need to be very careful in the closing process. First of all, they should verify all wiring instructions before transferring their funds by calling the title company. Also, they should be aware that it’s extremely rare that wiring instructions will change at the last minute or that this information will be provided by email.

    In order to protect their money, it would be a good idea to confirm everything — for instance, to ask their bank to confirm the name on the receiving account before sending a wire. After wiring their funds, within 4–8 hours, they should call the title company to confirm they received their money.

    Homeowners can protect themselves from refinancing scams by working with established and accredited institutions. Some mortgage brokers practice less than ethical mortgage lending, but homeowners can rest assured if they are working with any established credit union or financial institution, as the offers provided by them will always be vetted and secure. Credit unions and banks are heavily regulated with a tremendous amount of transparency that allows consumers to make an informed, safe choice.


Nadia Evangelou
Nadia EvangelouSenior Economist and Director or Forecasting at the National Association of REALTORS®
Dr. David L Tuyo II
Dr. David L Tuyo IIPresident and CEO of University Credit Union

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About the Author


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Joe Cortez is a freelance journalist who covers personal finance topics, including mortgages, credit card rewards, and investing. He has previously written for USA Today, Business Insider, NextAdvisor, and Fodor’s Travel Guide.