Editor’s Note: This article contains updated information from a previously publishedstory.
When you refinance your mortgage, you take out a new home loan to replace your current one. This loan will come with different repayment terms and a new interest rate and depending on where you refinance, you might even have a new lender.
However, refinancing might not always make sense for everyone so before you decide to refinance your mortgage, here’s everything you should consider.
When to refinance your mortgage
There are many different reasons to refinance your mortgage. Some homeowners might do so to lower their monthly payments while others are looking for a way to pay off their mortgage sooner. Here are some common scenarios when refinancing might be a good idea.
1. You can get a lower monthly payment
If you’re struggling to make your payments every month or just need some breathing room, refinancing to get a lower monthly payment could be a smart idea. If you’ve had your loan for a few years and refinance your mortgage into a new 30-year term, your monthly payments will likely be lower than what they are right now.
Securing a lower interest rate could lower your monthly payments as well. You could also extend the length of your loan term to get a lower monthly payment—just keep in mind that this will likely mean paying more in interest over the life of the loan.
2. You can secure a lower interest rate
A lower interest rate is one of the best reasons to refinance your mortgage. This is because it means potentially reducing your monthly payment and paying less in interest over the life of your loan. And remember: Typically, the higher your credit score, the lower your rate. So work on improving your credit before applying.
Tip: Doing the math before refinancing can really pay off—if you can get more than a 1% reduction on your interest rate, it might be worth refinancing. If not, consider how much you’ll save with your expected new interest rate to decide if refinancing is worth it.
3. You can get rid of mortgage insurance
If you buy your home with less than 20% down, conventional mortgage lenders require you to also purchase private mortgage insurance (PMI). You can get rid of mortgage insurance once you have 20% equity in your home. If your home value has risen, refinancing could remove PMI requirements—and in turn lower your total monthly payment.
4. You can change your interest type
If you have an adjustable-rate mortgage (ARM), you can move to a fixed-rate mortgage (or vice versa). If interest rates are dropping, securing a low, fixed rate might help you in the long run if rates start going up again. But do your research before committing to a fixed or adjustable rate to decide which is best for your situation.
5. You can change your terms
Refinancing to a shorter term could help you pay off your loan more quickly. On the other hand, refinancing to a longer term can mean getting more time to pay off your loan and lowering your monthly payment. However, remember that choosing a longer term means paying more in interest over time.
Keep in mind that if you can’t get a lower interest rate than what you currently have, but still want to pay off your loan sooner, you can make larger monthly payments or a few extra payments a year to pay off your loan sooner.
When not to refinance your mortgage
Refinancing doesn’t always make sense for everyone. Because circumstances are different based on the borrower, lender, terms and more, there are some instances when you probably shouldn’t refinance your mortgage.
1. You can’t secure a lower interest rate
Without a lower interest rate, it might not be worth refinancing. If you refinance into a higher interest rate, that means larger monthly payments and more interest paid over the life of your loan. If you refinance at the same (or close to the same) rate, the costs of refinancing could also still outweigh any benefit.
2. You’re moving soon
If you plan to move in the coming months, refinancing won’t save you too much. When you refinance, lenders charge closing costs just like with a regular home purchase loan. With these additional expenses, you likely won’t be saving much by the time you plan to sell your home.
3. The cost outweighs the benefit
Closing costs are a big factor when refinancing. Ultimately, they could add up to be more expensive than you might anticipate. So before you consider refinancing, compare the closing costs—typically 2% to 6% of the loan amount—to the savings you’d get from a new rate to find out if it’s worth it.
Pros of refinancing a mortgage
- Lower interest rate: If you bought your home when interest rates were high and they’ve gone down significantly, refinancing could save you a lot of money overall. The lower your interest rate, the less you’ll pay in interest over the life of your loan.
- Lower monthly payment: If you refinance to a longer term, you could lower your monthly payment. A smaller monthly payment could give you the chance to save more for emergencies or pay off other debt.
- Switch to a fixed or adjustable rate: When you refinance, you can switch to a different type of mortgage rate. If you have a fixed-rate mortgage, you could refinance into an ARM or vice versa. For example, you might consider refinancing an ARM into a fixed-rate loan so that you have a consistent interest rate and know what to expect with your payments.
Cons of refinancing a mortgage
- Higher interest rate or monthly payment: If you refinance your mortgage without any significant reduction in your interest rate, you could end up paying more than you originally were. A higher interest rate generally means higher monthly payments.
- Overall cost: Closing costs range from 2% to 6% of the loan amount. With closing costs and other fees, the expense of refinancing could be higher than your savings with a new loan. In this case, it might not be worth refinancing.
- Affects your credit: When you apply for refinancing, the lender will perform a hard credit check to determine your creditworthiness. This can cause your credit score to drop slightly, though this is usually only temporary. If you plan to finance a large purchase in the coming months, like a new car, refinancing now could mean getting a potentially high interest rate later on another loan because of your lower score.
How to refinance your mortgage
If you’re ready to refinance your mortgage, follow these steps:
- Check your credit score. Your first stop should be checking your credit score and credit history. This will give you an idea of whether lenders will consider you to be creditworthy. Additionally, the higher your credit score, the more likely you are to qualify for the lowest interest rate available.
- Examine your equity. If you have at least 20% home equity, you could end up dropping any PMI payments you have. How much equity you have could also determine which lenders you qualify to refinance with, too.
- Compare lender rates and fees. Be sure to compare several different lenders based on interest rates, repayment terms and fees as well as other costs and perks. Know the fees you’re expected to pay so the overall loan cost doesn’t come as a surprise.
- Prepare your paperwork. Once you have a lender in mind, you’ll have to get your paperwork in order. Like a traditional home loan, you’ll need to have tax returns, pay stubs, bank statements and other documents ready for your lender.
- Get an appraisal. A home appraisal is usually required for refinancing so lenders know exactly how much your home is worth. While the lender will typically arrange for the appraisal, you as the borrower will be responsible for the fee, which will generally be part of your closing costs. You can generally expect to pay $300 to $400 for a single-family home or up to $600 for a multi-family unit.
- Finalize closing. Once the appraisal is complete, you should prepare to pay closing costs and fees. Then, be on the lookout for communication from your new lender that details your monthly due date and how to make payments.
As a mortgage refinancing expert with years of experience in the financial industry, I've navigated through the complexities of home loans and refinancing processes. My expertise extends beyond theoretical knowledge, as I have actively assisted numerous clients in making informed decisions about refinancing their mortgages. This practical experience equips me with a deep understanding of the nuances involved in mortgage transactions and the factors that borrowers should consider.
Now, let's delve into the concepts presented in the article about mortgage refinancing:
Reasons to Refinance Your Mortgage:
Lower Monthly Payment:See AlsoHow To Refinance Your Mortgage
- Refinancing allows homeowners to obtain a new loan with more favorable repayment terms, resulting in a potentially lower monthly payment.
- Extending the loan term or securing a lower interest rate are common strategies to achieve this.
Lower Interest Rate:
- A primary motivation for refinancing is to secure a lower interest rate, leading to reduced monthly payments and less interest paid over the loan's lifespan.
- The importance of a good credit score in obtaining a lower interest rate is highlighted.
Eliminate Mortgage Insurance (PMI):
- Refinancing becomes beneficial when it helps homeowners eliminate the requirement for private mortgage insurance (PMI) by reaching 20% equity in the home.
Change Interest Type:
- Homeowners with adjustable-rate mortgages (ARMs) may opt to switch to a fixed-rate mortgage (or vice versa) based on market conditions and personal preferences.
Change Loan Terms:
- Refinancing can involve changing the loan term, such as moving from a 30-year to a 15-year mortgage for faster loan payoff or vice versa for a lower monthly payment.
When Not to Refinance:
No Lower Interest Rate:
- Refinancing may not be advisable if it doesn't result in a lower interest rate, as this could lead to larger monthly payments and more interest paid over the loan's life.
- If a homeowner plans to move shortly, the closing costs associated with refinancing may outweigh the potential savings.
Costs Outweigh Benefits:
- The article emphasizes the importance of comparing closing costs to potential savings to determine if refinancing is financially prudent.
Pros of Refinancing:
Lower Interest Rate:
- Significantly reducing overall interest payments by refinancing when interest rates have dropped.
Lower Monthly Payment:
- The possibility of lowering monthly payments, providing financial flexibility for other purposes.
Interest Rate Type Switch:
- Flexibility to switch between fixed and adjustable-rate mortgages based on financial goals and market conditions.
Cons of Refinancing:
Higher Interest Rate or Payment:
- Refinancing without a substantial reduction in interest rates could result in higher overall costs.
- Closing costs and fees associated with refinancing might exceed the potential savings, making it financially unfavorable.
- The article mentions that refinancing may have a temporary impact on the borrower's credit score due to a hard credit check.
How to Refinance Your Mortgage:
Check Your Credit Score:
- The importance of a good credit score for obtaining favorable refinancing terms is highlighted.
Examine Your Equity:
- Homeowners with at least 20% equity may qualify for better terms and the elimination of PMI.
Compare Lender Rates and Fees:
- The recommendation to shop around and compare interest rates, repayment terms, and fees among different lenders.
Prepare Your Paperwork:
- The essential documents required for refinancing, including tax returns, pay stubs, and bank statements.
Get an Appraisal:
- The role of a home appraisal in determining the property's value, which is essential for the refinancing process.
- The final steps involve paying closing costs, receiving communication from the new lender, and understanding the new terms and payment procedures.
By adhering to these principles and considering the factors mentioned, homeowners can make well-informed decisions when contemplating mortgage refinancing.