When Should You Refinance a Home

What is Mortgage Refinancing?

Mortgage refinancing replaces your existing home loan with a new one in order to achieve a lower monthly payment or a shorter term. Some borrowers also refinance to tap their home equity.

How Does Refinancing Work?

The process of refinancing is similar to shopping for a mortgage. You’ll need to submit pay stubs, tax returns, and bank statements and meet the same credit score and debt-to-income requirements to qualify. If your credit score has improved since you bought your home, this could help you get a lower interest rate. However, you’ll incur many of the same closing costs that come with a mortgage, such as an appraisal fee, origination fee, and title fee. So you’ll need to make sure the savings more than offset the costs.

How Long Does It Take to Refinance?

You can expect it to take around six weeks to refinance a mortgage, but individual factors may impact the time it takes to close.

How Much Does Refinancing Cost?

Freddie Mac puts average closing costs around $5,000, but your loan size and location will influence the total burden. You can expect to pay some or all of the following:

●     Origination/application fees and underwriting fees

●     Appraisal fees

●     Credit report fees

●     Title and tax service fees

●     Survey fees

●     Attorney fees

●     Government recording fees

No-closing-cost mortgages are available, but you’re not actually avoiding closing costs with these products. Instead, the costs are typically covered with an inflated interest rate, and you may end up paying more over the life of the loan.

Types of Refinancing

The process and costs of refinancing can also vary depending on the type of mortgage refinancing you choose.

●     Rate-and-Term Refinance: With this type of refinance, the borrower gets a new loan with either a lower interest rate or a different term. Most borrowers will choose a shorter term to save money on interest, but there are situations when it can make sense to lengthen the term in order to lower the monthly payment.

●     Cash-Out Refinance: This involves replacing your existing loan with a larger mortgage and keeping the difference as cash. Typically, this results in a higher monthly payment, but if you can also achieve a lower interest rate, you may be able to keep your payment the same while tapping your home equity. Still, closing costs make this one of the more expensive ways to borrow against your equity, especially if you only need a small sum.

●     Cash-In Refinance: This involves putting a lump sum towards a new mortgage in order to increase your equity, lower your monthly payment, or reduce your interest rate.

●     Streamline Refinance: Streamline refinancing is available for loans backed by the FHA, VA, or USDA. With these programs, you can avoid repeating the appraisal process, save on some closing costs, and even avoid a credit check. Borrowers with VA-backed loans will also pay a lower funding fee on the refinance.

When Should You Refinance a Home?

Refinancing to Save Money on Interest

One of the most common reasons to refinance is to save money on interest, and there are a few ways borrowers can achieve this goal.

By Snagging a Lower Rate

If mortgage rates have taken a plunge since you bought your home, refinancing can reduce your interest rate and monthly payment. You might also be eligible for a lower interest rate if your credit score has improved since you bought your home. Generally, borrowers with a FICO score of 760 or above get access to the best refinancing rates, though options may be available to borrowers with a lower credit score.

By Shortening the Term

Typically, 15-year mortgages come with lower interest rates, and shortening the term also reduces the amount of interest you pay over time. If your income has increased since you bought your home and you can afford a higher monthly payment, refinancing to shorten the term of your mortgage can save you money over the life of your loan. It’s also possible that you could take advantage of a lower interest rate and shorten the term without substantially increasing your monthly payment.

By Bringing Cash to Close

If you have a lump sum of cash you can contribute towards your mortgage, you can also get a lower interest rate with a cash-in refinance. But if interest rates have come up since you purchased your home, you’ll likely be better off making extra payments than refinancing. A cash-in refinance makes the most sense when you can also achieve a lower rate or when you plan to keep your home for many years.

Refinancing to Eliminate Mortgage Insurance Premiums

If you took out an FHA mortgage and paid less than 10% down, you’re stuck paying mortgage insurance premiums for the life of your loan unless you refinance. These can easily cost several thousand dollars per year, so if you plan to keep your home for a while, it’s often worth replacing your FHA-backed loan with a conventional one.

Refinancing to Tap Your Home Equity

A cash-out refinance replaces your current mortgage with a larger one, so you can use the cash difference to fund home repairs, cover an emergency expense, or fulfill another financial need. However, unless you can simultaneously lower your interest rate by refinancing, you’ll likely find that other methods of tapping your home equity will be cheaper. For example, home equity loans and home equity lines of credit generally have lower closing costs than a refinance. If you have good credit, you can also avoid closing costs altogether by taking out a personal loan.

Refinancing to Change Your Loan Structure

If you started off with an adjustable-rate mortgage and you’re worried about fluctuating interest rates once the fixed interest period has come to an end, refinancing with a fixed-rate mortgage can ensure you still have predictable monthly payments. You might also refinance from a fixed-rate mortgage to an ARM if you want to snag the lower initial interest rate and you plan to sell your home within the next few years.

Is Refinancing Worth It?

It can be well worth the costs if you can save enough money on interest over the life of the loan. For example, let’s say you took out a $200,000 mortgage ten years ago with an interest rate of 5%. If you could achieve a 4% interest rate from refinancing, you would save more than $21,000 in interest over the life of your mortgage. But it would take you nearly five years to break even from $5,000 in closing costs, so if you planned to sell your home before that point, it wouldn’t be worth the savings.

To find out if refinancing is worth it in your unique situation, you should start by comparing refinancing rates among lenders. You’ll want to prequalify with a handful of lenders first, which won’t impact your credit. You can prequalify with lenders individually or use a loan comparison marketplace. Using the lowest estimated interest rate, enter some details into a mortgage refinance calculator. A good calculator will show you your breakeven point, monthly payment difference, and total interest savings. If refinancing makes sense for you financially, you can then formally apply with a few lenders and close with the company that can offer you the best rate.

Can You Refinance Whenever You Want?

While there is no limit to how many times you can refinance, some lenders will impose a waiting period of six months or more after your first loan payment. It’s especially likely that you’ll have to wait if you’re applying for a cash-out refinance, and there can be equity requirements to meet as well. Government-backed loans have their own seasoning period as well.

●     FHA and VA Loans: 210 days after closing and six months after your first mortgage payment

●     USDA Loans: 12 months after closing

When Is It a Bad Idea to Refinance a Mortgage?

When You Won’t Save Money Over the Life of the Loan

If a refinance calculator reveals that your interest savings won’t offset your closing costs, you shouldn’t refinance, even if it lowers your monthly payment. There is one exception, however: If you are refinancing to get a longer term and a lower monthly payment because your current mortgage is unaffordable, you may not save any money, but it may still be worth it to refinance so that you don’t default on your mortgage.

When You Won’t Break Even in Time

Your break-even point is the month at which you’ll have saved enough money in interest to cover the closing costs of refinancing. Essentially, it’s the point at which the refinance has paid for itself. If you plan to sell your home before you’ll break even with a refinance, it won’t be worth it.

When There Are Better Alternatives

Even if refinancing saves you money or allows you to tap home equity that you need, it won’t be a good idea if other alternatives are more financially sound.

Alternatives to Cash-Out

If you need to access home equity, there are a few alternatives that have lower or no closing costs. You should compare the cost of a cash-out refinance with these options.

●     Home Equity Loan: A home equity loan allows you to borrow a lump sum of cash against the equity in your home. Depending on the lender, you may be able to borrow up to 85% of the equity in your home. And closing costs will be less than with a refinance.

●     HELOC: With a home equity line of credit, you can borrow as needed against the equity in your home during the draw period, which typically lasts 10 years. You only need to make interest payments during that time. Once you enter the repayment period, larger monthly payments will be required, but you only need to pay back what you used of your available equity.

●     Personal Loan: Personal loans don’t come with closing costs. Instead, you’ll pay more in interest than you would with a cash-out refinance, home equity loan, or HELOC. Two-year personal loans have an average APR of 8.73%, according to the most recent data from The Fed. But if you have good credit, a personal loan could be more advantageous than a cash-out refinance. And some lenders offer up to $100,000.

Alternatives to Cash-In

If you’ve received a windfall of cash or a pay raise, a cash-in refinance isn’t the only way to use that money to save on your mortgage. It often works just as well to make extra payments towards your mortgage or to request that your lender recast your mortgage, especially if rates are the same or have increased since your purchase mortgage. Recasting often comes with a small fee, but you won’t have to pay thousands in closing costs.

Remember that once you have at least 20% equity in your home, you can also request that your lender cancel your private mortgage insurance. You don’t need to refinance to get rid of PMI.

Frequently Asked Questions

What Credit Score Is Required to Refinance a Mortgage?

For a conventional refinance, you’ll generally need a FICO score between 620 and 720, depending on your cash reserves, debt-to-income ratio, current loan-to-value ratio, and lender requirements. For FHA loans, you’ll need a minimum credit score of 500 if your loan-to-value ratio (LTV) is 90% or less and 580 if it’s over 90%. Some FHA streamline refinances won’t require a credit check at all. VA and USDA refinances don’t have specific credit requirements, but you’ll generally need to meet individual lender requirements and demonstrate that you can repay the loan.

What Should You Do if You Can’t Afford Your Mortgage?

Refinancing is one option. It’ll work best if you have at least 20% equity in your home and can get a lower interest rate, but you can also lower your mortgage payment by getting a longer term. Your lender may also agree to modify your loan term without the need to refinance. If you’re experiencing temporary financial hardship, you can also request forbearance. Renting out a portion of your home to help with the monthly costs is also an option, and if your home is worth more than you owe, you can always sell.

Can You Lower Your Mortgage Payment Without Refinancing?

It’s possible to lower your monthly mortgage payment without refinancing if your lender agrees to recasting or mortgage modification. Another way to achieve a lower payment is to make a large payment towards the principal, especially if it will help you remove private mortgage insurance.

How Do You Remove a Co-Signer on a Mortgage?

If your lender has established rules for co-signer release, you’ll just need to meet the requirements. Typically, you’ll have to have made on-time payments for a number of months. You can also request cosigner release from your lender directly. If your lender isn’t willing to remove the other person’s name from your loan, you’ll need to refinance in your name only. That means you’ll need to meet the financial requirements for the mortgage on your own.

How Do You Get Rid of Private Mortgage Insurance?

Once you have at least 20% equity in your home, you can request that your lender cancel PMI. If the lender won’t allow it or you want to try to trim your interest rate, refinancing is another option. You can also wait until you have 22% equity in your home, at which point your loan servicer must cancel your PMI by law.