Though mortgage rates have risen slightly, homeowners can still access better rates on average than they have in years. Interest rates remain below three percent, according to Freddie Mac. While that’s creating competition for homes that is leading to rising prices for homebuyers, it’s great news for people looking to save money on a new mortgage with refinancing.
How Does Refinancing Work?
When you refinance, you take out a new loan that replaces your existing mortgage. The process is similar to applying for a new home loan. That means you’ll need to qualify for the new loan based on your credit score and income. The difference is that the money goes towards paying off your mortgage rather than going to the seller for the home’s purchase. There are closing costs and other fees involved when you refinance, but these are often offset by the savings you’ll achieve from getting a lower interest rate.
Should I Refinance?
There are several reasons homeowners might want to consider refinancing:
- Lower Monthly Payments: You can achieve a lower monthly payment by either refinancing with a lower interest rate or extending the term of the loan. This can help if you’re struggling to afford your mortgage payment.
- Fixed Monthly Payments: Another reason to refinance is to achieve the security that comes with fixed monthly payments. If you have an adjustable-rate mortgage, you might worry about your monthly payments increasing. Refinancing to a fixed-rate mortgage will ensure your monthly payments stay level.
- Lower Interest Overall: You’ll pay less over the life of the loan if you pay it off faster. Some homeowners may choose to refinance from a 30-year term to a 15-year so that they can pay less overall. This usually results in higher monthly payments, but if you’re also able to get a much lower interest rate, the difference could be minimal.
- Access to Home Equity: You can use a cash-out refinance to borrow more than you owe on your mortgage and keep the difference in cash. You may choose to do this if you need access to cash. Many people are also able to get a lower interest rate with a cash-out refinance.
- Stop Paying FHA Mortgage Insurance Premiums: It’s easy to cancel private mortgage insurance once you’ve established 20 percent equity with a conventional loan, but if you want to stop paying mortgage insurance premiums on your FHA loan, you’ll need to refinance once you have enough equity.
How Much Does It Cost to Refinance?
The total cost will depend on several individual factors, such as your credit score, the amount you’re borrowing, and the term you choose. However, you can generally expect the cost to be between three and six percent of the loan amount, according to Quicken Loans. Usually, these closing costs are offset by savings on interest over time, but you’ll need to do the math to ensure that’s the case. You should also compare lenders when shopping for a refinance loan, since each one will offer different rates and fees.
How Much Could I Save by Refinancing?
That depends on the rates and term of both your current mortgage and your refinance loan. Savings from achieving a lower interest rate can be surprisingly substantial, however.
For example, let’s say you purchased a $300,000 house two years ago and made a 20 percent down payment, borrowing a total of $240,000 at an interest rate of 5.5 percent. If you’re able to refinance with a 28-year term and a three percent interest rate, you could save $21,628 in the first five years by paying less interest. You’d break even after only a year. Over the life of the loan, you could save more than $100,000.
Types of Mortgage Refinance Loans
Rate and Term Refinance
This common type of refinancing involves replacing your existing mortgage loan with a new loan that either has a different interest rate, a different term, or both. For example, you might refinance your 30-year fixed rate mortgage with a five percent interest rate to a 15-year fixed rate mortgage with a three percent interest rate. Whether you adjust the rate or the term, the goal is to save money over the life of the loan. If you keep the term the same and lower your rate, you’ll also achieve lower monthly payments.
Cash-Out Refinance
If you need access to some of the equity you’ve built in your home, one way to turn equity into liquid cash is with a cash-out refinance. This involves replacing your existing loan with a loan that covers more than what you owe on your mortgage. Your lender will give you a check for the difference.
Cash-In Refinance
With a cash-in refinance, you’re adding a lump sum of equity to the loan in order to reduce the loan-to-value ratio and obtain a lower interest rate. You bring cash to the table when closing a cash-in refinance, but you’ll achieve lower monthly payments and save money on interest over time.
Streamline Refinance Programs
A typical mortgage refinancing process can take up to 30-45 days, though can be shorter or longer depending on specific circumstances, and requires you to provide documentation of your income, employment, and assets in addition to submitting to a credit check. But certain government-backed loans are eligible for streamlined refinancing, which may not require a credit check and may even help you save money on closing costs.
FHA Streamline Refinance
Limited underwriting is required for an FHA Streamline Refinance, so you can bypass a credit check and won’t need to pay for a home appraisal. You’ll need to have an existing, current (not delinquent) FHA mortgage, and the refinance must benefit you by allowing you to save money on interest overall or lower your monthly payments. Cash-out refinancing in excess of $500 isn’t allowed with the FHA Streamline Refinancing program.
VA Streamline Refinance
The VA interest rate reduction refinance loan (IRRRL) allows borrowers with an existing VA-backed mortgage loan to refinance without verification of income, assets, or credit score. As with the FHA Streamline Refinance program, cash-out refinancing isn’t allowed. You’ll need to show that you live or lived in the home covered by your mortgage to be eligible.
USDA Streamline Refinance
Borrowers with a current USDA-backed mortgage may be eligible for Streamlined Assist Refinance Loans, which don’t require a credit check, debt or asset verification, or a home inspection or appraisal. You’ll need to have made on-time payments for the last 12 months and gain at least a $50 net reduction in principal, interest, real estate taxes, and homeowners insurance payments when compared to what you were paying before.
Fannie Mae’s High-LTV Refinance Option
If you took out a loan backed by Fannie Mae on or after October 1, 2017, you may be eligible for Fannie Mae’s High-LTV Refinance Option, which is designed for borrowers with little or no equity in their homes. This program offers streamlined documentation requirements and allows the borrower to transfer mortgage insurance to the new loan. To be eligible, you need to be on-time with your monthly payments and be able to benefit from the loan in some way, either by achieving a lower monthly payment, saving money on interest, or getting a fixed-rate loan to replace an adjustable-rate mortgage.
How to Refinance Your Mortgage
- Know Your Goals: Do you want to achieve a lower monthly payment, save on interest by getting a shorter term, do away with mortgage insurance premiums, or access liquid cash? It’s important to establish the reason for refinancing upfront. This will impact which option you choose.
- Know Your LTV: Your loan-to-value ratio is your current loan balance divided by the current appraised value of your home. Your lender will assess this ratio when determining your interest rate and approving you for refinancing.
- Know Your Credit Score: Unless you’re eligible for streamlined refinancing, you’ll want to make sure you’ve maintained a high enough credit score to get a lower interest rate when refinancing. You can access your credit report for free at AnnualCreditReport.com.
- Shop Around: Before formally applying, you should get quotes from a handful of lenders. Some may be able to offer lower interest rates than others. Be sure to pay attention to fees as well.
- Calculate Your Net Benefit: Estimate the total fees and closing costs associated with your refinance, and compare those costs to the savings you’ll achieve over time. It’s okay if you have to bring cash to closing, but you should be able to break even and start saving relatively quickly.
- Formally Apply: Gather all your documentation and lock in your interest rate with the lender of your choice. You’ll also likely be required to pay for a home appraisal before being approved.
- Close the Loan: There may be out-of-pocket costs associated with this process.
- Repay the Loan: Do what you need to do to make sure you stay up-to-date with your monthly payments, including making any necessary adjustments to your budget or setting up automatic withdrawals from your checking account.
FAQ
Will Refinancing Hurt My Credit?
Refinancing will cause your credit score to decrease temporarily, both because of hard inquiries on your credit report from loan applications and the new loan that you haven’t started paying off yet. To minimize the impact, apply for loans within a two-week period so that they’ll only count as one inquiry for FICO credit score purposes, and make sure you keep up with payments on your existing mortgage until refinancing is complete.
Once you start to make on-time payments on your loan, your credit score will, all else being equal, bounce back. What’s more, it might even improve if refinancing allows you to free up some cash to pay off debt and keep your utilization ratio low.
When Is It a Bad Idea to Refinance?
First, you should use a refinance calculator tool to make sure you’ll save enough money on interest to offset closing costs. You should also determine when you’ll break even. If refinancing will cause too much financial strain because of out-of-pocket costs in the short-term, it might not be a good idea, even if you’ll save in the long run. In general, refinancing also becomes less beneficial the further you get into the term of your mortgage, since the potential interest savings decrease over time.
Can I Save Money on Interest without Refinancing?
You can typically save money on interest by prepaying your mortgage. You might make a lump sum payment towards the principal in addition to your monthly payments when you receive extra cash, like an inheritance or stimulus check. You might also add extra to each monthly payment as your income increases. Or, you could reevaluate your budget to make an extra mortgage payment once per year. All of these tactics will shorten the life of your loan and allow you to build equity faster and save money on interest.
Are There Other Ways to Tap My Home Equity?
Yes. A cash-out refinance isn’t the only way to get money from your house. If you need a lump sum to pay some medical bills, for example, you can take out a home equity loan. Or, if you’ll need ongoing funds to finance a home improvement project or other expenses, you can apply for a home equity line of credit (HELOC), which allows you to use your equity like a credit card for a period before you start repayment.
Can I Still Refinance if I Have a Second Mortgage?
Yes. You can either replace your first and second mortgage with a new loan, or keep your home equity loan or HELOC and only refinance your first mortgage. The first option is typically easier, faster, and usually results in lower rates, but it’s not always possible. You may have prepayment penalties on your home equity loan or need access to your HELOC. In that case, you’ll need to ask the lender to subordinate your second mortgage in escrow. This can take time, so if you can, take care of it before you apply for refinancing.
The information contained herein is provided for free and is to be used for educational and informational purposes only. Consult a financial professional for specific help with your situation.