Refinancing your mortgage can be an effective way to restructure your finances to save money, or to borrow some of the equity you’ve built up to pay for major expenses. If you’re considering it, you’ll want to assess your goals, loan terms, and market conditions so you can refinance your mortgage in a way that will benefit you the most.
Here’s a deeper look into 10 questions to ask yourself and mortgage lenders when refinancing your home loan.
1. Why Should I Refinance My Mortgage?
The biggest reason to refinance your mortgage is to save money — either in the short term or the long term. Here are some common reasons why qualified borrowers refinance:
- To secure a lower interest rate. If interest rates have dropped, you could refinance to a lower rate and pay less total interest. Just remember that extending your loan term can diminish that benefit depending on how much longer you’ll be making payments.
- To reduce your monthly payment. A lower interest rate or longer loan term can lower your monthly payment. While this frees up more of your income for other expenses, it can cost you more in interest because you’ll be making payments longer.
- To own your home sooner. Shortening your loan term will help you build equity and pay off your mortgage more quickly. It also will increase your monthly payment.
- To tap into your equity. If you have equity, you could borrow against it with a cash-out refinance and repay it as part of your new mortgage. This can give you access to significant amounts of money for home improvements, college expenses, or consolidating high-interest debts.
- To switch to a fixed-rate mortgage. The interest rate on an adjustable-rate mortgage changes based on market conditions. If rates have increased, you’re paying more interest and making a higher monthly payment with an ARM. Refinancing to a fixed-rate mortgage would lock in your interest rate for the life of the loan, ensuring a stable monthly payment.
- To switch to an ARM. ARMs usually offer a lower interest rate than fixed-rate loans for an introductory period that typically lasts three, five, or seven years. After that, your rate and monthly payment adjust — usually once a year — and likely will increase at some point. If you plan to sell your home before the introductory rate expires, an ARM can help you save money.
“Most importantly, people should carefully consider their long-term objectives,” says Jerry Koors, president of Merchants Mortgage in Indianapolis. “For some clients, it is to get the lowest payment possible. For others, it may be debt consolidation. And (for) others, it could be to save interest and pay their home off sooner. Once that objective is set, then consulting with a mortgage professional on the best ways to achieve those objectives is the next step.”
2. What Should I Know About My Current Mortgage?
If you’re considering a mortgage refinance, the first step is to review your current loan. You’ll want to know how far along you are in paying off your loan, how much equity you have, and whether your loan has a prepayment penalty.
Here are key elements to consider:
- Interest rate. Compare your current loan’s interest rate with market rates to see if refinancing can help you save money on interest.
- Interest rate type. Refinancing from an ARM to a fixed-rate loan can stabilize your monthly payment and make it easier for you to budget for the future, while switching to an ARM can help you save money if you don’t plan to own the home for long.
- Loan term. If you’re just a few years into paying off your mortgage, and refinancing will lower your monthly payment, then it may be worth extending your loan term. If you’re 10 years in, then restarting a 30-year loan term means 10 additional years of paying interest.
- Principal balance. If you’re close to paying off your mortgage, then it may not be worth the additional costs of refinancing and restarting your loan term.
- Equity. If you’ve built a substantial amount of equity in your home, then you can refinance and borrow cash against it to spend on projects like home improvements that increase your property’s value.
- Mortgage type. If you have a conventional loan but your income and credit have declined, you could refinance to a loan backed by government agencies — such as the Federal Housing Administration or Veterans Affairs— to make your mortgage more affordable, if qualified.
Our free mortgage refinance calculator can help you understand how these factors work together.
3. What Are My Refinancing Options?
These are some common refinance options.
A rate-and-term refinance, sometimes known as a regular refinance, will pay off your old mortgage with a new loan that has a more favorable interest rate or loan term — without taking out cash and increasing your loan balance. A rate-and-term refinance can help you get a lower interest rate, reduce your monthly payment, and give you more time to pay off your loan. In other cases, it can help you repay your mortgage faster and pay less interest.
A cash-out refinance allows you to take advantage of your equity by paying off your existing mortgage with a larger loan, and withdrawing the difference in cash.
Let’s say your initial home loan was for $400,000, and you owe $250,000. That means you have $150,000 in equity. You could refinance to a new loan worth $270,000 and get $20,000 in cash a few days after closing. Lenders typically will let you refinance up to 85% of your home’s value, and you repay the cash as part of your new mortgage.
Another common reason to refinance is to consolidate high-interest debts, such as credit cards. This involves using the money from a cash-out refinance to retire those debts, effectively rolling them into your mortgage. This method allows you to repay expensive debts over time and at a lower interest rate. While your monthly mortgage payment would go up and you may pay more interest overall, your other debts would be paid off — giving you more breathing room in your budget.
You can think of a cash-in refinance as the inverse of a cash-out refinance. Instead of increasing your total loan amount to borrow cash now, a cash-in refinance lets you make a lump-sum payment that reduces your principal balance. If you’re making more money, or you have access to more funds, you can replace your current mortgage with a smaller loan and, likely, a lower monthly payment.
But cash-in refinancing comes with certain trade-offs. By putting a large sum of cash into your mortgage, you’ll have less money on hand to pay for other expenses. Additionally, your current mortgage may have a prepayment penalty, where you’ll be charged for paying off the loan too soon.
4. What Do I Need To Qualify for a Refinance?
Before you can refinance, you first need to make sure you’re eligible. While different lenders will have varying requirements, here are some common determining factors:
- A good credit score. As you saw when you first took out your mortgage, lenders zero in on your credit score to determine how reliable you are in paying off your debts. If your credit score is high, then you can score a lower interest rate. At minimum, you should make sure your credit score hasn’t dropped, or you might not be able to get a better deal on a refinance.
- At least 20% equity. It’s generally not advisable to refinance unless you have at least 20% equity in your home. While it’s possible to refinance with less, you’ll likely be charged a higher interest rate, and have to pay for private mortgage insurance.
- A low debt-to-income ratio. An important area of your finances that lenders will consider is your DTI ratio. Our free DTI ratio calculator can help you figure it out. You’ll want to keep your DTI ratio low, as a high ratio can indicate you’re more likely to miss a mortgage payment.
- All the required documents. Just like when you applied for your original mortgage, your lender likely will collect documents required for refinancing, such as your pay stubs, tax returns, and monthly bank statements.
5. How Much Will It Cost To Refinance?
One of the most important questions to ask a lender when refinancing your mortgage is how much it will cost.
According to Freddie Mac, closing costs for a refinance typically will cost about $5,000. Here are some of the major costs to consider:
- Interest rate. Your new interest rate affects how much you pay each month and overall. If the new interest rate is higher than your initial rate, it may not be worth refinancing.
- Application fee. Your lender may charge an application fee of up to $500.
- Loan origination fee. Your lender will charge a fee to set up your new loan and cover the cost of underwriting.
- Appraisal fee. The value of your home may have changed since you first bought it, so your lender will order a refinance appraisal. This typically costs between $300 and $600.
- Title services. Your lender likely will require another title search to check if there are existing liens on the property. This costs roughly $75 to $200.
- PMI. You’ll need to purchase PMI if you’re refinancing a conventional loan with less than 20% equity. PMI typically will cost between $30 and $70 per month for every $100,000 borrowed.
6. How Can I Save Money on Refinancing?
Here are some ways to save money on refinancing:
- Changing your interest rate type. If qualified, you could refinance from an ARM to a fixed-rate mortgage. If interest rates have dropped, this can help you lock in a lower rate and pay less each month and in the long run.
- Opting for a no-closing-cost loan. With a no-closing-cost refinance, you can skip paying your closing costs upfront. Instead, they’ll be added to your mortgage principal, or you’ll pay a higher interest rate.
- Using a price-matching program. If your current lender has a price-matching guarantee, it may be willing to match a competitor’s offer to keep you as a customer.
7. How Do I Know If Refinancing Is Worth It?
To determine if it will be worthwhile to refinance your mortgage, consider different aspects.
“Before refinancing, the customer should consider the total cost of the transaction, and not merely rely on the payment savings,” Koors says.
Koors also encourages borrowers to consider their break-even point, which is how long it will take before your savings exceed the cost of refinancing. For example, reducing your monthly payment by $75 sounds great, but the trade-off might not be worth it.
“If it cost $3,000 to do it, that is 40 monthly payments just to break even,” Koors says.
When to consider refinancing
Here are some conditions that can mean it’s a good time to refinance your mortgage:
- Interest rates have dropped. If interest rates have fallen since you first took out your mortgage, you may want to consider refinancing to score a better rate.
- You plan to stay in the home for a while. If you aren’t planning on moving and can get a lower rate, then the money you’ll save in the long run may cover the additional costs of refinancing.
- Your income has increased significantly. If you’re making more money, then you may be able to afford higher monthly payments. Refinancing to shorten your loan term will help you pay less interest overall and build equity faster. However, you should check whether your lender will charge a prepayment penalty, and factor that cost into your decision.
- You want to lock in your interest rate. If you have an ARM, then your interest rate can increase, and you’ll have to pay more each month. You can avoid market fluctuations by refinancing to a fixed-rate mortgage.
When to avoid refinancing
Here are situations when refinancing usually isn’t a good idea:
- Your credit score has declined. If your credit score has dropped since you first took out your home loan, it could limit your ability to get a better interest rate.
- You plan to move soon. If you aren’t planning to stay in the home for long, then you might not have enough time to recoup the cost of refinancing.
- The value of your home has fallen. If your home isn’t worth as much now, then it’s going to be more difficult for you to get a better deal on a new mortgage.
- Interest rates have increased. If interest rates are higher than when you first took out your home loan, it might not be a good time to refinance.
8. How Do I Find a Good Mortgage Refinance Lender?
Before you commit to refinancing, you’ll want to shop around and compare mortgage refinance lenders to make sure you’re getting the best deal on the interest rate and fees. Because you’ll be entering a long-term financial relationship, it’s important that you feel comfortable with your choice. You should compare customer service and satisfaction reviews to find out whether the company is reputable.
Another way to compare lenders is by using loan estimates. This form tells you key details about the loan you’re being offered — including the estimated interest rate, monthly payment, and total closing costs. Lenders are required to provide a standardized form, so you should be able to easily compare offers to find the best fit for you.
9. How Long Will It Take To Refinance?
Refinancing a home typically takes about 30 to 45 days. However, the exact length of time can vary depending on your financial situation and lender. For example, if your finances are complex and your income is harder to verify, then it can extend the underwriting process. Other factors that can affect how long it takes to refinance include scheduling appraisals and home inspections.
If you’re doing a cash-out refinance, you can expect to receive the money three to five days after closing.
10. What Are the Downsides of Refinancing?
There can be drawbacks to refinancing depending on when and how you do it. Here are some scenarios to consider:
- If you refinance to a lower interest rate with a longer loan term, you’ll save money in the short term — but you’ll end up paying more overall.
- If you refinance to shorten your loan term, you’ll pay less interest, but you may be charged a prepayment penalty.
- If you refinance when the interest rates have increased or your credit score has dropped, you might not be able to get more-favorable terms compared with your original mortgage.
The Bottom Line on Questions To Ask Before Refinancing
Refinancing can be a savvy way to save money by getting a better deal on your mortgage. Just make sure you talk to a lender and figure out what works best for your situation. These talks should include the important questions to ask when you refinance, so you can be more sure that your new mortgage is a better fit.