A Guide to Refinancing Your Mortgage: When and How to Do It

Mortgage refinancing is the process of paying off an existing mortgage loan with the proceeds from a new mortgage loan. The new loan typically has different terms from the original loan, such as a lower interest rate, shorter loan term, or different type of loan. Refinancing can enable homeowners to lower their monthly payments, build equity faster, or access their home’s equity.

Why Should You Consider Mortgage Refinancing?

There are several reasons why homeowners choose to refinance their mortgages:

1. Lower Interest Rate

The most common reason to refinance is to obtain a lower interest rate than your current mortgage. As of October 11, 2023, the average 30-year fixed mortgage interest rate is 6.02% (Source: Freddie Mac). By refinancing at a lower rate, you can reduce your monthly payments and total interest paid over the loan term.

For example, refinancing from a 30-year loan at 6% interest to a new 30-year loan at 5% interest could save you over $2,800 per year on a $300,000 balance (Source: NerdWallet). Over 70% of homeowners who refinanced in 2021 lowered their rate by at least 0.5% (Source: Mortgage Bankers Association).

2. Shorten Loan Term

Refinancing into a shorter loan term, such as from a 30-year to a 15-year mortgage, can enable you to build equity faster and pay off your loan sooner. Although your monthly payments will be higher, you’ll pay less interest over time.

3. Cash Out Equity

With a cash-out refinance, you can tap into your home’s equity and take cash out. This can help finance home improvements, debt consolidation, large purchases, college tuition, and more. Requirements vary by lender, but you typically need at least 20% equity to do a cash-out refinance.

4. Change Loan Type

Refinancing enables you to switch to a different type of home loan, such as from an FHA to a conventional loan. This allows you to find better terms.

5. Debt Consolidation

By rolling high-interest credit card balances and other debts into your new mortgage loan, you can save money with a lower interest rate on your debt.

How Does Mortgage Refinancing Work?

The basic process of mortgage refinancing is:

You apply for a new home loan from a lender with the terms you want
The lender evaluates your credit, income, debts, and home value to approve you
Once approved, you undergo underwriting, provide documentation, get an appraisal, and receive a closing disclosure

At closing, your new loan pays off and replaces your existing mortgage
You begin making payments on the new loan under its terms

Refinancing is similar to getting a new purchase mortgage, but with some different requirements. The mechanics are the same – you still have to qualify, document income/assets, and go through underwriting.

What Are the Steps Involved in Mortgage Refinancing?

Here are the typical steps to refinance a mortgage loan:

1. Determine Your Goal for Refinancing

First, decide why you want to refinance and what your objectives are. Do you want to lower your rate, shorten your term, tap equity, or get a different loan type? Know your goals upfront.

2. Check Your Credit Score and Financial Situation

Lenders will review your credit score, debt-to-income ratio, income, and other financial details. Before applying, check your credit and get your finances in order. A credit score over 740 gives you the best rates.

3. Research Different Lenders and Loan Options

Shop around with multiple lenders to compare interest rates and fees. Gather mortgage offers to find the best loan for your situation. Compare terms like rates, points, and closing costs.

4. Apply for the New Loan

Once you’ve picked a lender, complete a mortgage application and provide all required documentation. This verifies your financial situation.

5. Close on the New Loan

After underwriting, you’ll get a closing disclosure 3 days before closing. Then you sign the final paperwork, the new lender pays off your old mortgage, and the title transfers over.

What Are the Costs Associated with Mortgage Refinancing?

Closing costs are the main costs of refinancing, averaging $5,000-$6,000 (Source: NerdWallet). Common fees include:

Origination fee – Upfront fee from the lender, around 1-6% of the loan amount
Appraisal fee – Paid for home appraisal, typically $300-$500

Title insurance – Insures home title, around $700-$2,000
Recording fees – Paid to record new deed/mortgage, around $50-$200
Attorney fees – For document review, around $400-$1,500

You can either pay costs upfront or finance them into the new loan amount. No-cost and low-cost options are available too. Shop around to minimize fees.

What Are the Risks of Mortgage Refinancing?

Refinancing a mortgage can pose some risks that homeowners should carefully evaluate before making a decision. Potential downsides of refinancing include higher monthly payments if you refinance into a shorter term loan, as the monthly principal and interest will be higher even though you pay less interest over the full loan term.

Closing costs are another key risk, as refinancing fees can range from $5,000 to $6,000 on average; homeowners must calculate the break even point to ensure they recoup closing costs through interest savings before moving or selling the home.

Other risks include restarting the mortgage payoff timeline, increased loan amounts with a cash-out refinance, and the possibility of declining home values over time which could limit equity and refinance options. Adjustable rate mortgages also carry the risk of rising interest rates after the initial fixed period.

If your financial situation worsens in the future, it may be difficult to refinance again if you no longer qualify. Carefully evaluating these potential pitfalls before refinancing helps ensure it aligns with your financial goals.

How to Decide if Mortgage Refinancing is Right for You

When deciding if refinancing makes sense, homeowners should weigh several key factors including the interest rate difference between the current and new loan, closing costs, monthly payment savings, loan term changes, cash out equity needs, and credit/financial qualifications.

A general rule of thumb is that you should refinance if you can lower your interest rate by at least 0.5%, as this typically translates into significant interest savings over the loan lifespan. Crunching the numbers on closing costs versus monthly savings helps determine if you’ll reach the break even point before selling the home or moving.

It’s also important to consider if shortening or lengthening the loan term matches your financial objectives. Tapping home equity should also be evaluated based on your specific timeline and cash out requirements.

Changes in your credit score and/or financial situation may allow you to qualify for more favorable loan terms that weren’t available initially. Evaluating these criteria allows you to make an informed decision on if refinancing benefits your situation.

When is the Best Time to Consider Mortgage Refinancing?

Certain events or financial changes tend to signal optimal timing for refinancing, such as a substantial drop in prevailing mortgage interest rates which enables homeowners to reduce their current rate through refinancing.

Significant positive changes in your credit score may also open the door to better loan terms than you could have received previously. Building up additional home equity, whether through continued mortgage payments or home value appreciation, can provide more favorable loan-to-value ratios as well.

Stabilizing your financial situation, through paying down debts or increased salary, may allow you to qualify for a refinance after struggling initially. Major life events like marriage or having a child can also impact your finances and goals to make refinancing advantageous.

Acting strategically when these pivotal circumstances align with your objectives makes it more likely to maximize the benefits of refinancing.

How Can You Get the Best Deal on a Mortgage Refinance?

Refinancing your mortgage at the lowest possible rates and fees requires proactive effort, starting with checking your credit report and maintaining a strong credit score. Shopping multiple lenders and brokers, rather than just your current mortgage company, opens the door to a wider variety of rate offers and the ability to negotiate.

While it takes more effort upfront, comparing quotes from several lenders can mean thousands in interest savings. Mortgage brokers can often access wholesale lender rates not available to the general public. Asking about lender credits, discounts for autopay or upfront costs, and buying down the rate by paying points are additional avenues to reduce costs.

While it takes diligence, the savings potential makes it worth taking extra steps to secure the optimal mortgage refinance for your situation.

What Are Some Common Misconceptions About Mortgage Refinancing?

Despite its potential benefits, some persistent myths about mortgage refinancing may deter homeowners, such as believing you must wait a set amount of time before refinancing or that only those with financial problems need to refinance.

In reality, there are no mandatory waiting periods, and refinancing can benefit anyone seeking to improve their mortgage terms or tap home equity. Other misconceptions are that refinancing is free or quick and easy, when in fact closing costs and fees apply, and full underwriting is still required.

Assumptions that mortgage payments will remain static after refinancing are often proven false as changes in rate, term length, taxes, or insurance impact monthly costs. Outdated perceptions also linger about tapping enormous amounts of cash being easy or refinancing inherently risky, but prudent financial diligence dispels these notions. Separating refinancing fact from fiction is key to making sound decisions.