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How to Refinance Your Mortgage
By Aly J. Yale MONEY RESEARCH COLLECTIVE
Refinancing your mortgage can often come with several benefits. It may allow you to reduce your interest rate or monthly payment, change your loan terms, pay off your loan faster or even tap your home equity for cash. In some cases, refinancing can even help you achieve other financial goals, like paying off high-interest debts or credit cards.
Here’s what you need to know about refinancing and when you might want to consider it.
Table of Contents
- Guide to How to Refinance a Mortgage
- How Does Refinancing Work?
- Benefits of Refinancing Your Mortgage
- Risks of Refinancing Your Mortgage
- When Should You Refinance a Mortgage?
- Steps to Refinancing Your Mortgage
- Bottom Line to Mortgage Refinance
Guide to How to Refinance A Mortgage
The refinancing process looks very similar to the traditional mortgage process. You’ll fill out an application, submit documentation, have your home appraised and pay closing costs. Let’s go into some of the finer details now.
How does refinancing work
Mortgage refinancing, at its simplest, replaces your existing mortgage loan with a new one — often one with a different term, rate or loan type. After closing, your new lender will pay off your current mortgage balance, and from then on, you’ll only make payments toward your new loan.
Benefits of refinancing your mortgage
There are many benefits to refinancing your home mortgage. The exact ones you’d see depend on the loan type, balance, current interest rate and other details of your existing mortgage, but you may be able to:
- Lower your interest rate
- Reduce your monthly mortgage payment
- Change your loan term (going from a 30-year mortgage to a 15-year one, for example)
- Speed up your payoff timeline
- Get a lump sum, cash payment
- Remove mortgage insurance premiums (PMI on a conventional loan or MIP on an FHA loan)
Refinancing could also be helpful for homeowners with an adjustable-rate loan, as it could allow them to move to a fixed-rate mortgage and avoid potential rate and payment hikes.
Risks of refinancing your mortgage
Refinancing can certainly be beneficial, but it does come with some potential drawbacks and risks. For one, refinancing costs money. While you won’t need a down payment (as new homebuyers would), you will owe closing costs, just as you did on your initial home loan.
According to loan closing platform ClosingCorp, the average cost to refinance a mortgage was about $2,400 in the first half of 2021. To justify the costs of refinancing, you would need to remain in the home long enough to save $2,400 or more. (For these reasons, it’s generally not wise to refinance if you plan to move soon.)
In some cases, you might also owe a prepayment penalty from your original lender — typically around 2% of the loan balance. This is essentially a fee for paying off your loan before the lender could make enough profit. If your existing loan has this penalty in place (not all do), it will take even longer to reap the benefits of a refinance.
Finally, if you’re refinancing into a loan with a longer term, it could increase your interest costs significantly. This is why it’s critical to do both the short-term and long-term math when weighing a “refi.”
When should you refinance a mortgage?
There are many times when refinancing may be appropriate. Here are some times when you might want to consider it:
- Current mortgage interest rates are much lower than the rate on your current loan: Just make sure you have the credit score to snag that lower refinance rate. Lenders reserve the best mortgage rates for borrowers with credit scores of 760 and above.
- You can’t make your payments comfortably: If someone in your household loses their job or you have other budget changes, refinancing could make your payments more manageable.
- You have an adjustable-rate mortgage and would like to avoid a potential rate increase: Refinancing into a fixed-rate mortgage can give you a consistent rate and payment for the life of the loan.
- You need cash to cover home improvements or other costs: A cash-out refinance lets you turn your home equity into cash. You can then use this for home repairs or other expenses you might be facing.
- You want to get rid of PMI or MIP: If you’re currently paying Private Mortgage Insurance (PMI) or a Mortgage Insurance Premium (MIP), refinancing could get you into a loan that does not require it. You’d then enjoy a lower monthly payment as a result.
- You want to free up cash flow: Refinancing can often be a good way to free up extra cash each month, especially if you can qualify for a lower interest rate.
- You want to pay off your loan faster: Refinancing into a loan with a shorter term can help if you want to pay off your balance faster. This might mean refinancing from a 30-year loan into a 15-year or 20-year mortgage instead. (This is often called a term refinance). Just make sure you can afford the higher payments these refinances come with.
Keep in mind: You’ll need to have the money to cover closing costs if you decide to refinance. While many mortgage lenders offer “zero cost” refinances, these usually just roll the closing costs into your loan balance, raising your monthly payment and your interest costs in the long run.
Steps to refinancing your mortgage
Refinancing your mortgage is a fairly straightforward process. You’ll first need to do some calculations to make sure the move is right for your finances, and then you’ll shop around, apply for your loan and close on your new mortgage. Here’s the step-by-step process you’ll want to follow:
1. Decide if refinancing is right for you
Refinancing can certainly be a smart move for many, but it’s not right for all homeowners. To start, you’ll need to determine the goal you want to achieve with the refinance. Are you looking to save money? Change loan types or terms? Pay for upcoming expenses? Alleviate some financial pressure?
You should also think about your long-term plans. How long will you be in your home? Is your employment stable? Do you like where you live? If you’re unsure you’ll stick around for the next five to 10 years, refinancing may not be worth it.
Finally, use a refinance calculator to estimate the costs, mortgage payment and monthly savings and take into account the conditions of your current loan — what your rate is, the balance and if there are any prepayment penalties. Understanding these numbers and your goal for the refinance can help you determine if it’s right in your specific case.
2. Check your credit score
Next, you’ll need to check your credit score — particularly if you’re refinancing to lower your rate or reduce your payment.
Credit scores play a big role in the mortgage refinance rates a lender offers. And the better your score is, the lower your rate will be. (Conversely, a lower score will mean a higher interest rate).
Generally speaking, a 760 credit score will get you the lowest rate and save you the most money. If you’re below this threshold (particularly sub-600), take some time to improve your score before moving forward with the refinance. You can do this by paying down some debts, making on-time payments and correcting any errors on your credit report.
3. Compare lender rates
When you’re ready to get started, you’ll want to compare current mortgage rates from several lenders. You can do this by looking at loan marketplaces like LendingTree, Bankrate and Morty, or use other online rate-shopping tools you might find.
Just remember that many of the rates you’ll see are the lowest possible rates offered by the lender — not necessarily the rate you’ll get (especially if your credit score is low). The rates may also factor in discount points, which allow borrowers to pay an upfront fee in exchange for a lower rate.
4. Apply to multiple lenders
The next step is to apply with some of those lenders — ideally, a mix of big banks, online lenders and smaller, local banks, as this will give you the biggest range of options. If you have a real estate agent you trust, you can ask them for possible lender recommendations, and you can also use our guide to the best mortgage refinance companies.
Once you’ve narrowed down a few lenders, check the NMLS for each one. The NMLS, or Nationwide Multistate Licensing System, can offer details on where a lender is licensed to operate, any regulatory actions against the company and more.
You’ll then fill out the pre approval form for each lender you’d like to receive quotes from, and, after a day or two, they’ll give you a loan estimate. This personalized document breaks down your estimated loan amount, interest rate, monthly payment, long-term interest costs, closing fees and other important details. You can use these to compare each lender line by line.
5. Consider a co-signer
If you’re not seeing numbers you like on those loan estimates, it may be time to bring in a co-signer. Co-signers essentially agree to make your loan payments if you fail to do so yourself (it’s a way of financially vouching for you).
The benefit is that the lender will consider your co-signer’s credit score, income and debt-to-income ratio when evaluating your application. Doing so could make it easier to both get approved and receive a low refinance rate — especially if you have bad credit.
Just make sure the co-signer is aware of their responsibilities and agrees to them. If you fail to make payments and they don’t step in and help, it could hurt their credit score and financial options down the line.
6. Always read the fine print
As you’re deciding which lender to go with, make sure you read the fine print on your loan estimates. Look for any prepayment penalties (in case you want to refinance later on), and know how much you’d pay in closing costs and what would be due on closing day.
You should also look at details like the rate type (is it fixed or adjustable?), the rate lock period (how long is that rate guaranteed for?), the origination fee (lenders can vary widely on this) and any lender credits they’re offering you. These can help lower your costs and make refinancing more affordable.
7. Fill out the paperwork
Once you choose a lender, fill out their full application. You’ll also need to agree to a credit check and submit various documents. These typically include bank statements, tax returns, W-2s, pay stubs and other paperwork pertaining to your finances and assets.
You’ll be assigned a loan officer who will let you know if anything else is needed. They will also keep you informed as your loan moves through the underwriting process and will help coordinate an appraisal of your property if one is necessary. (Lenders usually require these for any cash-out refinance loan, as they confirm the current value of your home).
8. Keep making payments until approved
If your old mortgage due date comes up while your refinance is still in processing, you’ll need to make a payment just as you normally would. In the case of any overpayment, you would get reimbursed after the loan has been paid off by your new lender.
Once you’ve closed on your home refinance, you should receive payment details from your new lender within a few weeks. If you haven’t heard from them by the time your new payment is due, you can call their servicing department or wait it out. Most lenders have a grace period for late payments, particularly for new borrowers.
The Bottom Line to Mortgage Refinance
Refinancing your mortgage loan can often reduce your costs, alleviate financial pressure or help you access your home equity. If you’re considering refinancing, shop around for your lender and rate, and be prepared for closing costs. You can also speak to a financial advisor about your mortgage refinance options and for help determining if a refi is right for your finances.
