Wondering whether you should refinance your mortgage, how to do it and when?
We’ve put together answers to some of the most frequently asked questions about mortgage refinancing.
Here’s What You Need to Know About Mortgage Refinancing
If you’re a homeowner, refinancing your mortgage is a tool that could save you thousands of dollars. Here’s what you need to know:
Table of Contents
- What Is Mortgage Refinancing?
- When Should You Refinance Your Mortgage?
- How Much Money Will You Save?
- What Fees Will You Pay?
- What Kind of Credit Score Do You Need?
- Where Should You Look for a Refinance?
1. What Is Mortgage Refinancing?
Mortgage refinancing is a financial transaction in which you replace your current mortgage with a new one to gain some kind of financial advantage — such as a lower interest rate or a change in the length of your payment terms.
In general, you might consider refinancing your mortgage if you fall into one of these categories:
- You want a lower monthly payment. In this case, you might refinance into a loan term that’s equal to or slightly longer than your current term. But recognize that you’ll end up paying more interest over the life of the loan.
- You want to get out of debt faster. Refinancing from a 30-year mortgage into a 15-year is a slam dunk for saving money long-term, but your payment will be higher each month.
- You’re moving from an adjustable-rate to a fixed-rate mortgage to lock in a lower interest rate.
- You want to pull cash out of the equity in your home with a cash-out refinance (something money expert Clark Howard recommends only in limited circumstances).
2. When Should You Refinance Your Mortgage?
Clark Howard has a simple rule for this. We’ll get to an explanation of the associated costs with refinancing in a moment, but first here’s his rule:
“If you can make back the cost of the refinance in 30 months or less, you should do it,” Clark says. “It just makes financial sense. That’s the trigger.”
So you need to be sure you’ll stay in the house for at least two and a half more years to make up the cost of refinancing. Clark says most people end up staying in a house longer than they anticipate, but just be sure you plan to cross that 30-month threshold.
You can see if you meet this threshold by using our mortgage refi calculator.
3. How Much Money Will You Save?
To get a sense of how much money you’ll save by refinancing your mortgage, you can use our user friendly mortgage refinance calculator.
As you type in your numbers, make sure to take a look at what your monthly payment would be if you refinance into a 15-year mortgage.
Rates on 15-year loans are lower than those on 30-year loans. That’s because they’re a lower risk to lenders since they’ll get their investment back in half the time. The trade-off is that you’ll have a higher monthly payment on a 15-year loan. But if you can swing it, a 15-year mortgage is an opportunity to get out of debt in half the time.
“One of my favorite kinds of refinancing is going from a 30-year loan to a 15-year loan. If you have more than 23 years left on a 30-year mortgage and you refi into a new 30-year loan, you’ll extend the time you’re in debt,” Clark says. “But if you choose a 15-year loan instead, you’ll cut your interest rate even more and pay off the mortgage sooner.”
If you can’t afford the payments on a 15-year refi loan, Clark suggests looking at a 20-year refi instead.
4. What Fees Will You Pay?
You should expect to pay anywhere between 2% to 6% of your loan amount in closing costs to refinance your mortgage, according to LendingTree.
The fees you pay fall into two categories:
- Closing Costs
While exact closing costs vary by state, the average for a single-family home was $6,905 including taxes ($3,860 excluding taxes) in 2021. That’s according to ClosingCorp, a leading provider of residential real estate closing cost data.
Closing costs include fees for a lot of things: a property appraisal and pulling your credit report — as well as fees for processing, underwriting, attorneys, notarizing the transaction and title insurance. Depending on where you live, there might be more.
It is possible to refinance without paying closing costs upfront, though you’ll pay a slightly higher interest rate. But you’ll save so much money in the long run if you reduce your loan term. That’s why Clark says no-closing-cost refis can be a win/win.
If you do choose to go the route with closing costs, you’ll often have the option to pay those costs upfront or roll them into your new loan.
The consumer champ says the former is a smarter move. “If you’re going to stay in the property for enough years, you want to prepay the closing costs,” notes Clark. “Because otherwise, you’re paying interest every month on the money you rolled into it, so you’re taking away some of the advantage.”
Mortgage points are another kind of fee you need to know about. A point represents 1% of the total amount of money borrowed.
There two kinds of points:
- Origination points: This is simply a junk fee to line lenders’ pockets.
- Discount points: Money paid in advance to lower the interest rate over the life of a loan.
Want to compare the cost of two mortgages – one with points and one without? You can use our mortgage points calculator However, Clark has a simple rule when it comes to points: Never pay points to buy down your interest rate!
Keep in mind that not every lender charges points — credit unions often don’t — so if you can avoid paying points entirely, all the better.
5. What Kind of Credit Score Do You Need?
The factors determining your eligibility for refinancing your home include not only your credit score but also three additional key elements:
- The ratio of your debt-to-income (DTI): This is the proportion of your total monthly gross income that is dedicated to paying off debts.
- The loan-to-value (LTV) ratio: This refers to the portion of your property’s market value that is covered by your mortgage.
- The specific type of refinancing option you select: Typically, these options encompass conventional loans, programs backed by the Federal Housing Administration (FHA), loans offered through the U.S. Department of Veterans Affairs (VA), and those under the U.S. Department of Agriculture (USDA).
|Minimum credit score
These are the minimum required, but if you want the best rates, you’ll want a higher credit score.
But it isn’t necessary to have an 800+ credit score to get a really great offer. As long as you can hit 760, you’ll basically get the same kind of offers as people who have top-tier credit, according to Beverly Harzog, a credit card expert and consumer finance analyst for U.S. News & World Report.
6. Where Should You Look for a Refinance?
One of the most common questions we get about refinancing at our Consumer Action Center is, “Which companies are the best to refinance a mortgage?”
Clark points out one place where you shouldn’t look — and that’s a big bank.
“Banks are so unbelievably inefficient as operations. So the mortgage market is being taken over by non-banks like Quicken Loans and others,” Clark says. “Non-banks run so much more efficiently than banks and can make a nice profit charging less on a mortgage than a giant bureaucratic bank.”
Clark says the first place you should look for a refinance is your local credit union — particularly for shorter-term refis like seven or 10 years.
If you’re not already a member of a credit union, check out their websites to you can see what rates they’re quoting. Or you can call a few around town to figure out which one you might want to join.
“Credit unions do more creative products with the whole design being to get you debt free instead of paying the bank forever and ever,” Clark says.
Meanwhile, some non-bank online lenders you may want to consider include:
The bottom line: You’ll likely save thousands of dollars on refinancing your mortgage if you shop around. Clark recommends that you get quotes from at least three different sources.
But don’t fall into the trap of getting hung up on interest rate alone when comparison shopping. The interest rate is the bright, shiny object most people tend to focus on. But it’s only part of how you compare one loan offer to another. You’ve also got to consider points, if any, and closing costs.
When you put the offers side-by-side and compare all three factors — interest rate, closing costs and points — you’ll be able to see which is the best deal.
With mortgage rates falling from record highs, refinancing may be a good way to secure a lower interest rate and pay off your housing debt faster with a shorter loan term. Or you can refinance your mortgage to get cash out of your home or move from an adjustable-rate to a fixed-rate mortgage.
If you can’t afford a higher payment on a shorter loan term, you can still refinance into a new, traditional 30-year term with a lower interest rate. Then just pay extra toward the principal each month if you can. By doing that, you’ll get out of debt faster without being tied to a higher payment.
If you have additional questions about refinancing your mortgage, reach out to our Consumer Action Center.