Mortgage refinance options — 2 of the best ways to save money

If you want to refinance your home, make sure you know which option is best for your financial situation. (iStock)

Owning a home has many benefits, but it can be expensive. If you currently own a home and you want to lower your monthly payment or reduce the overall cost of your home loan, you may consider choosing to refinance your mortgage.

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When you refinance your home loan, you replace your current mortgage with a new one. The new loan typically offers better terms (like a lower monthly payment, longer repayment terms, or lower interest rate).

As of June 25, the average interest rate on a 30-year fixed-rate mortgage is 3.13 percent and 2.59 percent on a 15-year fixed-rate mortgage. Mortgage interest rates are at or near historic lows in many areas as a result of the impact of COVID-19. Given mortgage rates have hit record lows in recent months, now could be an opportune time to refinance. You can use Credible's free tools to choose the refinancing loan that fits your needs.

If you choose a mortgage refinance, it’s essential that you understand your options and which type of refinancing would provide the most benefit for your financial situation.

Mortgage refinance options

When you’re refinancing your loan, decide what is most important to you:

  • Reducing your monthly payment
  • Saving money over the life of your loan

While you may be able to save on both your monthly payment and the total interest over the life of your loan, you may get maximum impact by focusing on one. Credible allows you to compare the mortgage refi rates available today so more money can end up in your pocket.

EVERYTHING YOU NEED TO KNOW ABOUT MORTGAGE REFINANCE

For refinancing, you have two basic options:

1. Refinancing your rate and terms

This type of refinancing replaces your current loan with a new one that has a lower interest rate and/or loan term (like the length of your repayment).

If you have a credit score of at least 700 and at least 40 percent equity in your home, you could qualify for exceptionally low-interest rates on your mortgage. Most lenders won’t even consider a refinance if you don’t have at least 20 percent in equity.

You might consider a refinance if your credit score isn’t quite high enough but you have at least 20 percent equity, as you could refinance for a lower monthly payment without a private mortgage insurance fee.

Another option is to refinance into a loan with different repayment terms. For example, if you have 15 years left on a 30-year loan, you could refinance into another 30-year mortgage. Your monthly cost would drop, but you’d pay more over time since your payments (and interest rate charges)  stretch over more time.

Alternatively, you could refinance a longer-term loan into a shorter-term mortgage (a 30-year into a 15- or 10-year fixed rate). Refinancing your loan to shorter repayment terms could increase your monthly payment, but you’d likely qualify for lower interest rates, and your total loan cost would be less since you pay interest fees for less time.

Make sure to use an online tool like Credible to find out what rates you qualify for right now.

HOW TO REFINANCE YOUR MORTGAGE

2. Cash-out refinancing

A cash-out refinance lets you access the equity you have in your home. You can lower your interest rate as well. When you do a cash-out refinance, the bank issues you a check for the amount you borrowed against your equity.

For a cash-out refinance, many lenders like to see an LTV (loan-to-value) ratio of at least 80 percent, but some lenders will allow a cash-out refinance if you have less equity. This type of refinancing acts like a loan (the loan balance is added back onto the amount you owe on your home), so you will have to pay closing costs and other fees.

While you can use the cash for any purpose, you could receive some tax benefits if you use the money for home improvement projects. You may consider this type of home refinancing if you need access to emergency funds at a lower interest rate, or you want to consolidate other debt at a lower interest rate.

WHAT IS CASH-OUT REFINANCE AND HOW DOES IT WORK?

Things to know before you refinance your mortgage

While interest rates are lower than ever, lenders are more strict about whom they approve. Make sure you work on raising your credit score (lower consumer debt and make all your payments on time), before applying.

If you want to refinance your loan, you should be current with your monthly payments; however, you may qualify for special refinancing even if your mortgage is in forbearance. Talk to your lender as soon as possible if you think you could be eligible.

Do the math. Use a tool like Credible to review offers from multiple lenders. Take note of fees and other costs associated with your refinance. Take a few minutes to look over the charges and decide if a refinance will save you money and if the savings are worth the effort.

WHEN SHOULD YOU REFINANCE YOUR MORTGAGE?