Refinancing your home can be an effective way to restructure your finances to save money, or to borrow some of the equity you’ve built to cover major expenses. Refinancing also can come with risks and drawbacks, so there are important questions you should ask both your mortgage broker, and yourself, before you make a move.
To determine whether refinancing can help you, you’ll need to assess your financial situation, your mortgage, and specific market conditions. Then, if you decide that now might be a good time to refinance, you’ll need more information about your new mortgage, and how it will affect your finances.
Here’s a deeper look into 10 questions to ask when refinancing your mortgage.
1. Why Should I Refinance My Mortgage?
The biggest reason to refinance your mortgage is that it can save you money — either in the short term or the long term. Here are some of the most common reasons why people refinance:
- To secure a lower interest rate. If interest rates have dropped since you took out your current mortgage, you could refinance to get a lower rate and pay less total interest. However, keep in mind that you could end up paying more overall if it takes longer to pay off your mortgage.
- To reduce your monthly payment. If you can get a lower refinance rate, and perhaps also extend your loan term, then you’ll be able to reduce your monthly payment. While this will free up more of your income for other expenses, it will increase the total cost of your mortgage.
- To own your home sooner. You could refinance to shorten your loan term and pay off your mortgage more quickly. This will help you build equity faster, but it also will raise your monthly payment.
- To tap into your equity. Home equity is the difference between the value of your house and the amount that you still owe on it. You can use this equity to borrow money at low interest rates to pay for home improvements or educational expenses, or to consolidate higher-interest debt.
- To switch to a fixed-rate mortgage. If you have an adjustable-rate mortgage, your interest rate can change based on market trends. If you want to have more certainty in what your monthly payment will be, then you can refinance from an ARM to a fixed-rate mortgage, where your interest rate will stay the same for the life of your loan.
“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 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 refinancing, then the first step to take is to review the terms of your current mortgage. You’ll also want to know how far along you are in paying off the loan, as this will affect how much equity you have and the total number of years you will be paying interest.
Here are key elements to consider:
- Interest rate. The interest rate on your mortgage influences your monthly payment and how much you pay overall for your loan. Compare your mortgage interest rate with market rates to see if refinancing can save you money on interest.
- Interest rate type. If you have a fixed-rate mortgage, then your interest rate never changes. But if you have an ARM, then your interest rate can change at certain intervals. Refinancing to a fixed-rate loan can stabilize your monthly payment and make it easier for you to budget for the future.
- Loan term. If you’re just a few years into paying off your mortgage, and refinancing will help you lower your monthly payment, then it may be worth extending your loan term. However, if you’re 10 years into paying off a loan, then restarting a 30-year mortgage term means 10 extra years of paying interest.
- Principal balance. If you’re close to paying off your mortgage, then it may not be worth the added costs of refinancing. But if you’re only a few years into paying off your mortgage, then refinancing to a lower rate can help you save significantly on interest.
- 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 the value of your house.
- Mortgage type. If you have a conventional loan but your income and credit have declined, you could refinance to an FHA or VA loan — backed by the Federal Housing Administration or the Department of Veterans Affairs, respectively — to make your mortgage more affordable.
3. What Are My Refinancing Options?
If you’re considering a mortgage refinance, your first question likely will be, “What are my choices?” Here 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 more-favorable terms when it comes to the interest rate or loan term. A rate-and-term refinance can help you get a lower interest rate, lower your monthly payment, and give you more time to pay off your loan. In other cases, it can help you pay off your mortgage more quickly and pay less interest.
A rate-and-term refinance also can be handy if you have an ARM and are looking for predictability in your monthly payment. The interest rate for an ARM can change, so if you want certainty in what you’ll pay each month, then you could refinance into a fixed-rate mortgage.
A cash-out refinance allows you to take advantage of your equity by paying off your existing loan 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. Then, you can refinance for a new loan worth $270,000 and get $20,000 in cash a few days after closing. Lenders will typically let you refinance up to 80% of your home’s total value, and you can use the money you borrow for anything — but keep in mind that it’s still a loan, and the amount is added to the total sum you owe.
Another common reason to refinance is to consolidate debt, especially high-interest debt like credit cards. This involves using the money from a cash-out refinance to retire other debts. It effectively rolls those debts into your mortgage, where you’re repaying them 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 monthly 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 come with certain trade-offs. By putting a large sum of cash in your mortgage, you will have less money on hand to pay for other expenses. Additionally, your mortgage may come with a prepayment penalty, where you’ll be charged for paying back the loan too soon.
4. What Do I Need To Refinance?
Before you can refinance, you first have 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 have the leverage to get a better deal on a refinance.
- At least 20% equity. It’s generally not advisable to refinance before 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.
- Low DTI. One of the aspects of your finances that your lender will look into is your debt-to-income ratio, which is a percentage calculated by adding up your monthly debt payments and dividing it by your monthly income. You’ll want to keep your DTI low, as a high figure can indicate that you’re more likely to miss a mortgage payment.
- All the required documents. Just like when you applied for your initial mortgage, your lender likely will ask to see pay stubs, W-2s (or 1099s), 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 will typically cost about $5,000. Here are some of the major costs to consider:
- Interest rate. Your new interest rate will affect how much you pay each month and overall. If the new interest rate is higher than your initial rate, now is not a good time to refinance.
- Application fee. When you apply to refinance, your lender will charge an application fee that can cost up to $500.
- Loan origination fee. Your lender will charge a fee to set up your new loan and cover the cost of underwriting, where your finances are reviewed to verify that you can afford your mortgage.
- Appraisal fee. The value of your home may have changed since you first bought it, so your lender will order a new appraisal. This typically costs between $300 and $600.
- Title services. Your lender also likely will require a title search to see if there are any existing liens against the property. This costs roughly $75 to $200.
- PMI. You’ll need to purchase private mortgage insurance 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 Will Refinancing Affect My Finances?
Refinancing your mortgage can be a savvy way to save money in the short or long term. However, it’s important to understand how refinancing can affect your financial situation. Here are some of the most common outcomes of a refinance.
You may reduce your monthly payment
If you refinance to a lower interest rate — and perhaps also a longer loan term — you can reduce your monthly payment. This can be a big deal for individuals or families looking to free up more of their income for other expenses. Also, if your job has changed since you first took out your mortgage and you aren’t making as much money, lowering your payment can give you more breathing room in your monthly budget.
You may pay more in overall interest
If you do refinance to lower your monthly payment, your loan term could be longer than the initial one. As a result, you’ll be making payments longer, which can add to both the amount you pay in interest and the amount you pay overall.
You can consolidate your debts
If you’ve accumulated a large amount of debt spread across several credit cards and other high-interest accounts, then you may decide to refinance to consolidate those debts. Doing so will allow you to pay off the debt at a lower interest rate and with just one payment each month.
You can extend or shorten your loan term
You also can refinance to change your loan term — either to shorten the length of the mortgage and pay it off sooner, or to extend the loan term and pay it off more slowly. Keep in mind that if you do shorten your mortgage to pay less overall, this likely means a higher monthly payment. Conversely, if you want to extend the length of your mortgage, you may get a lower monthly payment, but you’ll also pay more overall.
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. The break-even point 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 interest 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 are making more money, then you may be able to afford higher monthly payments. If you refinance to pay off your mortgage sooner, then you’ll pay less interest overall and build equity faster.
- You want to lock in your interest rate. If you have an ARM, then your interest rate can jump, and you will have to pay more each month. You can avoid these 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 may limit your ability to get a better interest rate.
- You plan to move soon. If you aren’t planning to stay in the house long, you may 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, then it’s going to be harder for you to get a better deal on a new mortgage.
- Interest rates have increased. If interest rates are higher than they were 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 and satisfied with your lender. You should compare the customer service and satisfaction reviews to make sure the company is reputable.
9. How Can I Save Money On Refinancing?
Here are some ways you can save money on refinancing:
- Changing your interest rate type. If you have an ARM and want to lock in a low rate that isn’t subject to change, you can refinance to a fixed-rate mortgage. If interest rates have dropped, this could help you 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 baked into your mortgage principal, or you’ll pay a higher interest rate.
- Using a price-match program. If your existing lender has a price-match guarantee, it may be willing to match a competitor’s offer to keep you as a customer.
10. 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 based 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 impact the timeline include your lender’s process and scheduling appraisals and home inspections.
If you’re doing a cash-out refinance, you can expect to get that money several days after closing.
The Bottom Line on Questions To Ask Before Refinancing
Refinancing can be a savvy way to save money and get a better deal on your mortgage — you just have to make sure you do it right and stand to benefit enough to make refinancing worthwhile. Now you know 10 important questions to ask when you refinance so that you can get the most out of your new arrangement, and improve upon the terms of your previous mortgage.