Refinancing Your Mortgage: How, When & Why?
The decision to refinance your mortgage can lead to several benefits. You can refinance to tap into your equity or save money in various ways. These include lower interest rates, eliminating private mortgage insurance (PMI) or shortening the term length of your mortgage.
A home may be your most expensive and most crucial investment, and for most homebuyers, a mortgage can make this purchase possible. There are several compelling reasons to consider refinancing your mortgage. Refinancing can be a way to meet significant financial goals.
However, before diving into the process, it’s smart to take a step back and make sure you understand the ins and outs. This will allow you to see the bigger picture and develop a strategy to achieve the best possible outcome for you.
Refinancing your mortgage can lower interest rates, leading to more affordable monthly payments. It can also allow you to tap into your equity to access funds without selling your home.
Properly timing when to refinance your mortgage is crucial. It’s smart to keep a lookout for changes in interest rates. Monitoring changes in your credit score is also an excellent idea.
Take the time to evaluate your situation before you refinance your mortgage. Have a clear goal in mind, factor in your credit standing and take time to speak with several lenders.
What Is a Mortgage Refinance?
Mortgage refinance may seem like a complex topic, but it’s basically taking out a new mortgage to pay your existing one.
It’s a loan with a new principal and a different interest rate. But since it takes the place of your original mortgage, you’ll only have one monthly payment.
When you apply to refinance your home, your lender will check your credit score. They’ll also review your income and tax history and assess your home’s current market value.
Lenders put all this information together to see whether you qualify for a loan. If you do, they’ll provide several options. These may include a lower monthly payment, a shorter term length or taking equity out of your home.
Refinance Savings for a $300,000 Mortgage
- RateMonthly PaymentPayments Over 10 Years
Why Should You Refinance Your Mortgage?
Refinancing your mortgage might seem like a risky move, but there are several reasons why you may consider it.
A mortgage refinance may allow you to get lower interest rates. Even half a percentage point can make a significant difference over the life of your loan. If you’re planning to live in your home for the foreseeable future, you can make this work to your advantage.
You could find yourself in a situation where you need to fulfill a financial obligation immediately. This could include paying for college tuition or a medical emergency. Refinancing your mortgage allows you to tap into your home’s equity and take it out as a lump sum. You can use the cash to pay off existing debts with high interest rates.
The section below outlines a comprehensive list of factors to consider. You’ll find more details about why a mortgage refinance may be a solid financial decision for you.
You can reduce your monthly payments by qualifying for lower interest rates. For example, moving from a 6% interest rate to 3% results in over $4,000 in savings each year. MoneyGeek’s mortgage refinance calculator can show you how much you can save if you decide to refinance.
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% could save you over $400 per month.
- Reduce your payments by eliminating PMI: Purchasing your home with less than a 20% down payment means you will probably pay private mortgage insurance (PMI) in addition to principal and interest. Once you have 20% equity built-in, refinancing can cut out the PMI payment, unlocking more savings.
- 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 will help you build equity faster.
- 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 give you a fixed rate for 10, 15 or 30 years. You’ll know your monthly payment won’t change, 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 on 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.
Risks to Consider Before Refinancing Your Mortgage
Despite all the benefits you can get if you refinance your mortgage, you’ll also want to consider potential drawbacks. Here are the major ones to think about before you take action:
- New closing costs and fees: You will be responsible for refinancing costs for your new loan. Closing costs and fees for things like home inspections can add up quickly. You can roll some of those into the loan, but keep in mind that doing so 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. You may need to pay cash out of your pocket to lock in your loan.
- Prepayment penalties: Some mortgages have prepayment penalties, meaning you’ll pay more if you decide to pay off your principal balance early. It’s smart to be sure you understand the terms and conditions before closing on your new loan.
- Longer break-even point: Extending the life of your mortgage by several years could push your break-even point further into the future, depending on how long you intend to live in your home. It’s a good move to use a refinance calculator to estimate your total savings and when you can actualize them.
- Underwater loans: If you take out too much money, you risk having a mortgage that is higher than your home’s value. When this happens, it’s known as “going underwater.” To avoid this trap, it’s important to understand the actual market value of your home before you sign loan documents.
When Should You Refinance Your Mortgage?
Timing is crucial in refinancing, and it’s best to pursue it when conditions work in your favor. However, it never hurts to begin preparing before the right time comes. This way, you’ll be ready to start the process immediately when you’re ready.
Here are some situations when a mortgage refinance is a good idea:
- Refinance when you find lower interest rates: Several factors affect your monthly mortgage payments. Your interest rates have the most considerable effect. Finding rates even half a percentage lower can dramatically reduce your monthly payments.
You can use your current interest rates as a starting point. Check with different lenders, and if you find lower rates, it might be a good time to refinance your mortgage.
- Refinance when your credit score increases: Lenders use your credit score to evaluate your creditworthiness. A good credit standing usually means you’ve managed your finances and debt obligations well.
Your credit score improves as you make your monthly payments on time and in full. Check your credit score and compare it to when you first took out your mortgage (or a shorter period). A better credit standing may mean better refinancing options are available to you.
Here are some factors to explore if you’re still on the fence about refinancing your mortgage. These may help you decide which option is best for you.
- Revisit your current financial situation. Your obligations may change over time, so it’s good to take a look at your financial goals. Think about your long-term objectives and factor in short-term goals. Try to estimate how a mortgage refinance would affect each of these.
- Weigh the benefits and drawbacks of refinancing your mortgage. There are advantages to refinancing your mortgage, but there are also potential disadvantages. You may get lower rates and more affordable monthly payments, but you’ll also need to consider possible risks. Refinancing may be a good option if the benefits outweigh the risks.
- Don’t rush, but don't wait too long either. Market conditions mean interest rates are constantly changing, so it’s good to take your time to look at economic conditions. However, don’t waste the opportunity if you see a significant shift in your favor. It may be a while before low rates come your way again.
How to Refinance Your Mortgage
Refinancing a mortgage shouldn’t be a snap decision. After weighing the pros and cons, you can outline your goals and take the necessary steps toward lowering your payment or taking cash out to achieve your financial goals.
Set a Goal for Your Mortgage Refinance
Before beginning the refinancing process, it’s smart to set a goal for your new mortgage. Are you motivated by saving money on your monthly payment? Or is taking out cash to consolidate debt or fund a big project more important to you? You can decide the best way to move forward with a refinance by setting a clear goal.
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 correct any erroneous information before requesting rates. Although you can refinance with bad credit, you may not qualify for the best rates.
Shop for Mortgage Refinance Rates With Multiple Lenders
Once you understand your credit, you can shop around by checking with several lenders to find the best rates. You can often request multiple quotes from lenders within 14–45 days of your first request without negatively impacting your credit. The specific time frame varies and depends on the credit scoring model used, so you'll want to confirm with your potential lenders which model they use beforehand. 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.
Select a Mortgage Refinance Lender and Lock in Your Refinance Rate
Once you’re satisfied that you’ve found the best option, it’s time to “lock in” your rate with the lender. It’s important to do this as soon as you’ve made your decision because mortgage rates change daily, and each day could mean a higher rate. Some lenders will allow you to “float down” if there’s a lower interest rate after you close, but this may come with an additional fee.
Prepare to Close on Your Refinanced Loan
Once you’ve locked in your rate, your lender will start the closing process. Like with purchasing your home, you will have to go through all the paperwork, including income verification and tax return information. Depending on the specifics of your refinance, you may also need to have your house appraised, which is an extra cost to consider.
Attend the Mortgage Refinance Closing
At the final step, you sign your closing paperwork and take full advantage of your refinance. 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.
- Why is the current market ideal for homeowners to consider a mortgage refinance?
- What questions do homeowners need to consider before refinancing?
- What should homeowners look for when comparing refinance offers?
- How can homeowners protect themselves from refinance scams?
Senior Economist and Director or Forecasting at the National Association of REALTORS®
President and CEO of University Credit Union
Professor of Economics at Villanova University
CFP®, CSLP®, Founder of Pulse Financial Planning
CFP®, AIF®, Founder of Impel Wealth Management
Director of Financial Planning at Taylor Hoffman Wealth Management, Inc.
Partner and Senior Wealth Advisor at Beacon Pointe
Associate Dean & Investments Limited Professor at Florida Atlantic University
Professor of Finance at the University of Wisconsin-River Falls
Associate Professor, Department of Finance and Real Estate, Villanova University
Associate Professor of Finance, Banking and Real Estate at the University of Nebraska Omaha
Senior Lecturer and Director of Financial Services Lab, Dept. Of Finance and Real Estate at American University, Washington DC.
Succession Program Director at Value Growth Institute and Associate Provost of Graduate Programs at The American College of Financial Services
Professor at Pratt Institute
Assistant Professor of Finance at the University of Wyoming
Ph.D., CFA, Assistant Professor of Finance at University of Missouri – St. Louis
Founder at Middle Class Dad Money
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