The first step to refinancing your home mortgage is ensuring it’s the right move for you.
Refinancing a home mortgage involves taking out a new loan that pays off and replaces your existing home loan. Usually, the goal is to lower your monthly payments by locking in a lower mortgage interest rate or adjusting the loan term. You can achieve this by understanding how to refinance your mortgage in a way that fits your long-term financial plan.
So, how does refinancing a mortgage work? We spoke with a 22-year mortgage veteran to understand the ins and outs of refinancing, when you should and shouldn’t change your mortgage terms and more.
Step 1: Decide if Refinancing is Right for You
Jason Lerner, area manager for First Home Mortgage and a 22-year mortgage industry veteran, says the first step in refinancing is double-checking that it’s a good move for your situation.
“People often say, ‘Oh, interest rates have dropped by 1%, so I should refinance,’ and that’s not true for everyone,” he says. “For some people, it might be much larger than 1%.”
Aside from market conditions, homeowners should look at their financial situation, loan balance and timeline. “If you’re now paying more principal than interest, you may be much better served making those payments,” Lerner says.
To get a comprehensive check, Lerner recommends reconnecting with the mortgage lender who worked on your first loan. “I don’t mean the company who services your loan,” he says, “I mean the loan officer who you personally worked with. Alternatively, you can get referrals from friends for people they trust.”
The lender might determine that refinancing is not right for you or may propose an alternative plan. If, on the other hand, they recommend refinancing your home loan, then it might be best to start the process as soon as possible.
“The market for the last several years has truly become unpredictable,” Lerner says. “If it makes sense to refinance, a consumer should aggressively move forward.”
Step 2: Pick a Refinance Type
There’s more than one way to refinance a home mortgage, each with its benefits and risks. Here, we’ll briefly overview the most common refinance types.
- Rate-and-term refinance: Simply put, a rate-and-term refinance allows you to adjust the interest rate or the term on your home loan without touching the principal balance.
- Cash-out refinance: A cash-out refinance replaces your existing home loan with a new, larger one to get money based on your home’s equity. The money you receive equals the difference between the first and second mortgages.
- Streamline refinance: A streamline refinance is available to borrowers with loans backed by the federal government, such as a USDA or VA loan. These processes have fewer eligibility requirements than conventional loans. Read more about USDA streamline refinance and VA streamline refinance.
- No-closing cost refinance: A no-closing cost refinance is what it sounds like. You won’t pay any upfront costs at closing, but you might be charged a higher interest rate or have the cost rolled into your new home loan.
Step 3: Shop for Lenders and Check Eligibility
Once you’ve decided which refinance type is right for you, you’ll want to start looking for lenders. While the eligibility requirements may differ depending on where you go, generally speaking, you should have a 620 credit score or higher and a debt-to-income ratio of 50% or lower.
RELATED: Best Mortgage Refinance Lenders
Step 4: Gather Necessary Documents
Technically, this step should come before you start shopping for lenders since just about everyone will ask you for financial documents to ensure your eligibility.
“Have the details about your financial position so the loan officer can complete a financial checkup,” Lerner says.
This includes the following:
- Two most recent pay stubs
- Two most recent W-2s
- Mortgage statement
- Information on your debts and assets
Step 5: Review Loan Documents
Lerner recommends reading through the lender’s loan documents yourself and having a financial planner, certified public accountant or other trusted person look them over.
“I encourage homeowners to make sure they review all the financial disclosures,” Lerner says.
One primary reason for this is to ensure that there are no hidden fees, prepayment penalties or other clauses that might make the refinancing more expensive than you thought.
Step 6: Have Your Home Appraised
This step may not be required for some refinancing types, such as streamline refinances. If it is mandatory, make sure your house is clean and any necessary repairs have been made. If you want to increase your home’s fair market value, consider upgrading things like the home’s plumbing and electrical systems.
Lerner says the typical house appraisal can cost around $600, though many lenders will roll the cost into the mortgage or final closing costs. You can also learn how to get a free house appraisal.
Step 7: Close on the Loan
Once everything is said and done, you’ll need to attend a closing, just as you did with your mortgage. If necessary, you might have to pay closing costs before the deal is finalized.
Your new loan will then take effect, and if you’re tapping into your home’s equity, you’ll receive your money in about three business days.
Why Refinance Your Mortgage
If you are unsure whether you need mortgage refinancing, below are a few common reasons to do so.
Shorten the Term
If you can afford to shorten the term of your mortgage loan, you could save significantly over the life of the loan.
| 30-year fixed rate @ 4.5% for $100,000 | 15-year fixed rate @ 4.00% for $100,000 |
| Principal and interest payment: $507 | Principal and interest payment: $740 |
| Total interest paid for 30 years: $82,407 | Total interest paid for 15 years: $33,144 |
| Savings over the life of the loan: $49,263 |
If you shorten the term from 30 to 15 years, the rate will be slightly lower, but the monthly payment will be higher. Throughout the loan, you’ll pay nearly $50,000 less in interest. Even $2,000 in closing costs makes this option a real savings benefit if you can afford the monthly payment plus taxes and insurance.
If you can stretch your budget for the higher monthly payment, consider another alternative. Leave your mortgage at a 30-year term but make the higher 15-year payment if you can. The savings won’t be quite as significant, but if an unexpected emergency crops up, you won’t be contractually obligated to pay the higher payment and can revert to the lower regular payment until the temporary hardship is resolved and higher payments can resume.
In the example above, if you wanted to pay off $100,000 at 4.5% in 15 years instead of 30, you would need to pay $765. The extra $258 would apply to the principal, reduce your balance faster and pay $44,708 less in interest over the life of the loan. Even those with 30-year jumbo mortgage rates can likely save by refinancing.
You can use a mortgage amortization schedule calculator to work all these figures.
Lower the Interest Rate
If rates happen to drop, you might be interested in a lower interest rate to save on your monthly payment over the life of the loan. It is wise not to add to the loan term but refinance based on the remaining payments in your loan. For example, if your current balance is $100,000 and the original loan was 30 years, and you’ve paid 10 years, you would want to refinance to a 20-year term.
| $100,000 over 20 years @ 5.5% | $100,000 over 20 years @ 4.5% |
| Principal and interest payment: $688 | Principal and interest payment: $633 |
| Total interest paid: $65,093 | Total interest paid: $51,836 |
Depending on the rate and closing costs, refinancing might be beneficial, but you should run some numbers to see if the difference in rate justifies the cost.
You would be saving $55 in your monthly budget and $13,257 over the life of the loan. If you account for a couple thousand in closing costs, your savings is around $10,000, which might be worth it. If the refinance rate was only a quarter percent lower at 5.25%, your monthly savings would be $14 and, over the life of the loan $3,370, which would barely cover the closing costs.
You’ll have to check and ensure the lower rate is worth the cost.
Lower the Monthly Payment
You can see the calculation above and the savings in monthly payments as they correlate to the interest rate. The above example only lowered the monthly payment by $14.
If your budget requires you to lower your monthly payment, you can choose to refinance and extend the term back to 30 years. Your monthly payment will go down, but you will pay more interest over the life of the loan.
| $100,000 original loan (30 year at 4.5%) | Balance after 10 years: $80,000 refi back to 30-year at 4.5% |
| Principal and interest payment: $507 | Principal and interest payment: $405 |
| Total interest paid: $82,407 | Total interest paid: $65,925 |
During the first ten years of the original loan, you would have paid nearly $40,000 in interest and refinancing to a longer-term means you paid that previous $40,000 plus the $65,925 for the new loan. You will pay approximately $23,518 more in interest than the original loan. When you extend the term, you’ll see short-term savings on your monthly budget, but you will pay more in interest over the life of the loan.
Switch from an Adjustable-Rate Mortgage to a Fixed-Rate Mortgage
Refinancing from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage can be beneficial. An ARM means that the loan is subject to rate adjustment over time. The initial rate is fixed for some time, then adjusts on a specific schedule and is tied to a publicly published rate with a designated margin markup.
For example, a 3/1 ARM loan means the initial rate is fixed for three years but adjusts each subsequent year following the third year.
For example, if the 3/1 ARM is tied to the U.S. prime rate and the loan originated in January of 2009, the Prime Rate was 3.25% plus a margin of 1%; the initial rate would have been 4.25%. The loan would remain at that rate until January 2012 and since the prime rate did not increase in 2012, that rate would remain in effect. In January of 2018, the prime rate was 4.5%, and with a margin of 1%, the newly adjusted rate would be 5.5%.
Assuming an original loan amount of $100,000 amortized over 30 years, the monthly payment would increase by $76 per month. If the rate continues to rise over the life of the loan, the payment increases as well.
A refinance can help to fix the rate and payment to stop the payment from increasing. If you have an ARM, you might want to check your original loan documents or ask the lender if there is a conversion option. Some ARM loan products offer the potential to convert the loan from an adjustable to a fixed-rate loan for a flat fee rather than paying the full closing costs.
Cash-out for Debt Consolidation
Another common reason for borrowers to refinance their mortgage is to cash out the equity in their home. Homeowners can use the equity in their home to pay for home improvement projects, college education expenses or pay off other existing debt. Since a home secures a home loan, the rates are typically lower than other types of financing, especially unsecured personal loans or credit cards. Refinancing with cash out to pay off debt can save you money in the long run and pay off the debt much faster.
You must determine how much equity your home has to see if this option might work for you. First, estimate how much the home is worth. If that information is provided, you can look at an old appraisal or the fair cash value on your tax assessment.
Next, determine how much you own on the mortgage. Most lenders won’t lend more than 90% loan to value. Multiply the home value by 90%, the maximum amount you can borrow against your home. (Home value of $100,000 * 90% = $90,000)
Take the 90% value limit minus what you currently owe; that number is a rough estimate of the remaining equity amount you can borrow against. (90% LTV limit $90,000 – current mortgage balance $50,000 = $40,000 in potential equity to borrow against)
What to Know About Refinancing Your Mortgage
If you’ve decided that refinancing your home mortgage is the way to go, here are a few key things to keep in mind:
- There are different ways to refinance a home mortgage, so pick the one that works best for you
- Have important financial documents ready
- Meet with a trusted financial pro to discuss your situation and goals
- Review all loan documents carefully
Why You Should Trust Us
Benzinga has offered investment and mortgage advice to more than one million people. Our experts include financial professionals and homeowners, such as Anthony O’Reilly, the writer of this piece. Anthony is a former journalist who’s won awards for his coverage of the New York City economy. He’s navigated tricky real estate markets in New York, Northern Virginia and North Carolina.
For this story, we worked with Jason Lerner, an area manager for First Home Mortgage and a 22-year mortgage industry veteran.
Frequently Asked Questions
Is it hard to refinance a mortgage?
No, it’s not hard to refinance a mortgage as long as you meet all the lender’s eligibility requirements. That said, the process can take a while depending on market conditions, the type of refinancing you seek and more.
How much equity do you need to refinance?
Jason Lerner, a 22-year mortgage industry veteran, says you can refinance with as little as 5% equity as long as you’re not seeking a cash-out refinance, in which case you’d need closer to 20% equity.
What disqualifies you from refinancing?
Factors that disqualify you from refinancing include a low credit score, high debt-to-income ratio and the inability to pay closing costs.
Sources
- Jason Lerner, area manager for First Home Mortgage and a 22-year veteran of the mortgage industry
About Anthony O'Reilly
Anthony O’Reilly is an updates editor for Benzinga. He’s won numerous journalism awards for his coverage of the New York City economy and Long Island school district budgets.