When you took out your current mortgage to buy your house, you might not have been in the financial position you are now. Your financial goals and position may have changed, yet you’re left paying the same monthly mortgage payment each month for the loan term or until you sell or refinance the home. Refinancing your home loan can give you a lower interest rate, a shorter term to repay the loan balance and/or a lower monthly payment.
What Is a Loan Refinance?
Over the course of the time you live in your home, the interest rates available for new mortgages will fluctuate based on the overall economy. You might have bought your home when interest rates were 5 percent, only to find they’re now only 3.6 percent. By refinancing, you can reduce the interest you’re paying on your home mortgage and save some money.
But saving on interest isn’t the only reason to drop your monthly payment. Your financial circumstances might have changed since you took that initial loan. Refinancing your mortgage can reduce your monthly payment to make it more affordable. It can also allow you to take advantage of any home equity you have as the result of increases in your home's value over the years. You can also switch to a 15-year mortgage term and pay it off quicker if your finances have improved.
When to Refinance Your Home
Before you get serious about refinancing your home loan, it’s important to make sure it’s the right time for refinancing. Refinancing comes with closing costs, so the biggest consideration is whether you’ll stay in the home long enough to make up the difference. Even if refinancing saves you thousands of dollars, that savings can be wiped out by the thousands of dollars in fees you’ll pay.
It's not just about how long you’ll remain in the home though. Before you can be approved for a refinance, you need to have some equity built up in the home. That typically means you’ve been there long enough for the market value to increase and your monthly payments to have reduced the balance on the principal.
One last consideration is whether your mortgage has something called a prepayment penalty attached to it. Refinancing pays off your first loan and creates a new loan. That means if you have a penalty for paying off the balance early, you’re charged an additional fee at closing.
Read More: Should I Refinance My Home?
Cost of Refinancing Your Loan
Refinancing comes with a cost, as any lender charges fees to issue a loan, whether it’s for a home or a car. Refinancing closing costs charged by mortgage lenders run between 2 and 6 percent and include the following:
- Application and origination fees
- Home appraisal
- Credit report fee
- Title search and settlement fee
You may also choose to pay “mortgage points” at closing. These points will buy down your mortgage rate, typically saving you 0.25 percent per point.
Reasons to Refinance Your Loan
There are certain times when a mortgage refinance makes sense. Here are some of the most common reasons to consider refinancing your loan.
- Reduce monthly payments: Once you’ve put some time into paying off your mortgage, you’ve reduced the balance of the amount you borrowed. So if your 30-year loan was $300,000 and you’ve paid $50,000, you now have a balance of $250,000. You can get a 30-year loan for $250,000 and reduce those monthly payments, especially since you’ll also be paying interest on a lower amount.
- Get a lower interest rate: Interest rates change from one year to the next. If the rate drops 1 percent or more, you could save significant money during the time you’re in the house by refinancing.
- Shorten mortgage length: Mortgage refinancing is often used to change a loan from 30 years to 15 years. That means you’re putting more toward the principal each month, which will help you pay the loan off faster. You save money on interest, and you'll own the home sooner than you would with a 30-year loan.
- Pay for college: Often homeowners consider refinancing when it’s time for the kids to head off to school. If refinance rates are low, you could get the extra money you need to pay tuition each semester.
- Tackle home improvement projects: Refinancing can give you the funds necessary to renovate your kitchen or add that back deck you’ve always wanted. You can do this as a cash-out refinance, where you get the funds you need in a lump payment, or by cutting down your monthly payment and using the extra funds for home improvement.
- Pay off debt: If you’ve accumulated some debt, it can be tough to get ahead of your bills. Reducing your monthly mortgage rate or taking a cash-out refinance can give you the extra funds you need to pay off credit cards, student loans and other high-interest debt.
- Change the loan type: You aren’t stuck with the same type of loan you got with your first mortgage. For example, you can refinance an FHA loan into a conventional or switch a variable-rate loan, also known as an adjustable mortgage, into a fixed-rate loan.
Read More: 5 Things to Know about a Variable Rate Mortgage
When to Not Refinance
There are some times when it's not a good idea to refinance your mortgage. Here are a few.
- Getting a worse deal: If your new loan will leave you in worse shape, it’s a bad idea to refinance. That great interest rate you’re seeing may be a variable-rate mortgage when you currently have a fixed-rate mortgage, for instance. With a variable rate, the interest you pay can change on a dime, while a fixed-rate mortgage locks you in at one rate for the life of the loan.
- Moving soon: With closing costs at 2 to 6 percent of the loan amount, it’s important you’re going to stay in the home long enough to make any benefits worth it. If you’re saving $100 a month in interest, you’d need to stay in the home 60 months, or five years, to recoup the $6,000 you’d pay on a $300,000 loan.
- Drop in credit score: If your credit score isn’t in tip-top shape, you may not get the best deal on interest. If, however, your credit score has improved substantially, you could get a better deal. For a conventional mortgage refinance, you need a score of at least 620.
Cash-Out Refinance and Mortgages
One of the biggest benefits you get when you refinance loans for a mortgage is the cash-out option. You can only do this if you have enough equity in the house to make it worth it for the lender. With a cash-out refinance, you get cash on hand to pay off debts, fund home improvements or pay for emergency expenses.
Before you decide to refinance your current loan to get money now, consider the dangers. A cash-out refinance today could lead to long-term financial problems if it puts you deeper in the hole. Weigh all the options and make sure taking cash on the equity in your home is truly the best way to go.
Read More: What Is Heloc vs. Home Equity Loan?
Help With Refinance Closing Costs
As you’re weighing your refinance options, the closing costs can seem daunting. But there are some ways to lower those costs. One is to shop around. Lenders competing for your business may agree to lower some of those fees. Also check with your existing lender to see if they can undercut what competitors are offering to keep your business.
If you simply don’t have thousands of dollars on hand, some lenders will agree to wrap closing costs into the loan amount. There are two issues with this: The lender typically charges more in interest to do this, and it bumps up the amount you must pay back. That means the interest you’ll pay over the life of your refinanced loan could be much higher than it would have been otherwise.
How to Refinance Your Mortgage
Once you’ve gotten the answers to all the FAQs regarding home loan refinancing, it’s time to get started. Here are the steps to follow if you’re ready to refinance.
- Scrutinize your mortgage payment: Note the principal balance and the interest you’re currently paying. This information will help you as you’re shopping around.
- Know what you’ll save: You can use a refinance calculator to crunch the numbers and make sure the amount you’re saving exceeds anything you’ll pay in closing costs.
- Shop around: It’s important to make sure you’re getting the best deal. Gather interest rates and ask for a list of closing costs from each. You can then compare and even take the offers back to your current lender to see if they’ll match it.
Read More: Buying a Home Programs: What You Need to Know
Streamline Refinancing for FHA Borrowers
Those with an FHA loan have another option for a mortgage refinance. FHA’s Streamline program makes it much easier to refinance an existing mortgage. You won’t have the paperwork and credit score requirements that you have when you refinance a conventional loan.
However, Streamline still has closing costs. They’re similar to the closing costs associated with your original FHA loan. Shop various lenders to find out what closing costs you’ll have to pay, as well as the interest rates available for Streamline loans.
Streamline Refinancing for VA Borrowers
Those with VA loans also have an easy refinancing option. Known as an interest rate reduction refinance loan, you can apply to have your original loan replaced by one with better terms. As with the first loan, you’ll need to present a Certificate of Eligibility to a participating lender to apply.
With an original mortgage loan, you can save on the down payment, which makes the closing costs worth it. With a refinance, there’s no down payment, so you may be more aware of the extra fee that’s added to your closing costs. This is called a VA funding fee, and it’s designed to offset the cost to taxpayers that comes from issuing a no down payment loan to veterans and servicemembers.
Streamline Refinancing for USDA Borrowers
For those whose mortgage was through the USDA home loan program, a USDA streamline refinance option is available. You can apply even if you have low or no equity in your home. However, to qualify for a refinance, your property must still be in one of the eligible rural areas. Since this can change from one year to the next, you need to check.
As with other streamline programs, you can replace your existing loan with another that has better terms. You won’t need an appraisal or a credit review, but lenders will verify that your mortgage has been paid on time for the past 12 months. You can also use part of the loan to pay closing costs, which makes the USDA streamline program an attractive alternative for those who don’t have thousands of dollars to spare.
Refinancing your mortgage can help you get a better interest rate or lower monthly payments. It’s important to take the time to shop multiple lenders and compare offers so that you’re getting the best deal available. Those with FHA, VA and USDA loans have options for easier refinancing than those who have conventional mortgages.
- USA.gov: Mortgages
- ConsumerFinance.gov: Should I Refinance?
- Experian: Your Guide to Refinancing a Mortgage With Bad Credit
- ConsumerFinance.gov: What You Need to Know If You Are Thinking About Using Home Equity to Cover Expenses During the Coronavirus Pandemic
- HUD.gov: Streamline Your FHA Mortgage
- VA.gov: Interest Rate Reduction Refinance Loan
- USDA.gov: Streamlined Assist Refinance Loans
Stephanie Faris has written about finance for entrepreneurs and marketing firms since 2013. She spent nearly a year as a ghostwriter for a credit card processing service and has ghostwritten about finance for numerous marketing firms and entrepreneurs. Her work has appeared on The Motley Fool, MoneyGeek, Ecommerce Insiders, GoBankingRates, and ThriveBy30.