Your home may be the largest investment you ever make, and your mortgage the largest debt you ever take on. Refinancing your mortgage can help you leverage that investment or reduce the cost of that debt.
Whether you’re refinancing to get cash out of your home, lower your mortgage payment, or pay off your loan faster, the following six steps will guide you through the process.
If you decide you’re ready to refinance, Credible makes it easy to see your prequalified mortgage refinance rates in minutes.
- How does refinancing work?
- Step 1: Check your credit score and history
- Step 2: Find out how much equity you have in your home
- Step 3: Compare multiple lenders
- Step 4: Get a loan estimate
- Step 5: Get your paperwork in order
- Step 6: Apply for a refinance
- When does it make sense to refinance your mortgage?
- Mortgage refinance FAQs
When you refinance, you take out a new mortgage that pays off your existing mortgage. If you do a rate-and-term refinance, you don’t make any changes to the loan amount — you just get a loan with a new interest rate, new loan term, or both.
With a cash-out refinance, your new loan has a larger principal balance than your old loan, and you get the difference as cash that you can use to cover home repairs, pay off other debts, or for other purposes.
Your credit score and history play a big part in whether you’ll qualify for a new loan, and the interest rate you’ll pay. Checking your credit report can tell you whether you’re ready to refinance or need to do some cleaning up before lenders take a look.
Some of the factors you should review include:
- Credit score — While minimum credit scores vary, most lenders require a credit score of at least 620 and reserve the best interest rates for borrowers with very good or exceptional credit scores — typically 740 and up. You can get a free copy of your credit report each year from the three main credit bureaus — Equifax, Experian, and TransUnion — from AnnualCreditReport.com.
- Any errors — If your credit score isn’t where you want it to be, check your credit report for errors that might be dragging your score down. As many as 5% of consumers have errors on their credit reports that could have a negative effect on their loan terms, according to a Federal Trade Commission study. Those errors might include accounts mistakenly reported as late, or having the same debt listed multiple times. If you find any errors, dispute them with the credit bureau to have them corrected.
- Debt-to-income (DTI) ratio — Another metric lenders consider is your DTI ratio, which is all your monthly debt payments divided by your gross monthly income. Many lenders prefer to work with borrowers with a DTI ratio no higher than 43%.
Home equity is the difference between the current value of your home and the amount you still owe on your mortgage. Knowing how much equity you have is crucial because it impacts everything from paying PMI to your available refinancing options.
When you apply for a mortgage, your lender will order an appraisal to calculate the formal value of your home. But you can estimate how much equity you have by looking up your home’s value online on Realtor.com, Redfin, or Zillow. Subtracting your current mortgage balance from that estimate can give you an idea of how much equity you have.
Most lenders require you to have at least 20% equity in your home to avoid PMI. For a cash-out refinance, lenders generally require you to have at least 20% equity in your home after taking cash out.
Shopping around and comparing rates and terms from multiple lenders will ensure you get the lowest rate and best terms for your situation. After all, rates and fees can vary significantly from lender to lender, even for the same type of loan.
If you’re refinancing to take advantage of a lower rate, you may be wondering how much the new interest rate should be to make it worthwhile to refinance. One rule of thumb is to refinance if your new rate will be 0.75% to 2% below your current rate. But even a more-modest rate reduction can be worth it if you plan to stay in your home long-term.
Because you have to pay closing costs when you refinance, you won’t realize any savings from a lower interest rate until you recoup those costs. And the smaller your rate reduction, the longer it takes to break even.
Calculate your break-even point
Use a mortgage calculator to see how much you’ll save each month. Then calculate your break-even point by dividing your closing costs by your monthly interest savings. If it takes you eight years to reach the break-even point and you plan to sell your home within five years, it might not make sense to refinance.
With Credible, you can easily compare mortgage refinance rates from multiple lenders.
Lenders might advertise low interest rates, but the only way to know for sure what rates and terms a lender is willing to offer you is to get a Loan Estimate.
A Loan Estimate is a three-page form that gives you important details about the loan you’ve applied for, including the interest rate, closing costs, and monthly payment.
To provide a Loan Estimate, lenders must perform a hard credit check. While a hard credit check can temporarily lower your credit score by a few points, you don’t have to worry that multiple credit checks while shopping for a refinance will harm your credit score drastically.
As long as you submit all your applications within a short period — usually 14 to 45 days — the credit-rating agencies recognize that you’re shopping around for a loan and will treat them as one inquiry.
Refinancing your mortgage is similar to the process you followed when you bought your home. Lenders will ask you to provide documentation to verify your employment, income, assets, and debts.
- Two years’ worth of W-2s
- Two years’ worth of tax returns
- Two most recent pay stubs
- Two months’ worth of bank statements for your checking, savings, and investment accounts
- A list of current debts and recent account statements
- A copy of your homeowners insurance policy
Once you’ve chosen a lender, it’s time to complete your loan application and submit your documents. Your lender can help walk you through the process. The lender will also typically order an appraisal to verify your home’s current value.
Getting from application to final approval can take time, but it usually averages 30 to 45 days. You can do your part to speed the process along by providing all necessary documents and responding to any additional requests as soon as possible.
It might make sense to refinance your mortgage for several reasons. Some common situations when you might want to refinance include:
- You want to lower your interest rate. If interest rates have gone down or your credit score has improved since you took out your mortgage, refinancing to a lower rate could help you save money over the life of your loan.
- You wish to tap your home’s equity. If your home is worth quite a bit more than you owe on your mortgage, you may be able to access some of that equity with a cash-out refinance. You can use the funds for virtually any purpose, including paying medical bills or covering your child’s education expenses.
- You plan to convert from a variable-rate to a fixed-rate loan. If you have an adjustable-rate mortgage (ARM), refinancing may allow you to lock in a fixed rate instead and enjoy the security of knowing your rate won’t go up over time.
- Your goal is to reduce your monthly payment. Refinancing your existing mortgage into a new 30-year loan term can lower your monthly payment, giving you more flexibility in your budget. Keep in mind that if you refinance to a longer loan term, you’ll pay more in interest over the life of the loan.
- You want to eliminate PMI. If you put less than 20% down when you purchased your home, you may be paying private mortgage insurance (PMI), which protects the lender in the event you stop making mortgage payments. If your home has increased in value, you may be able to refinance your loan to get rid of PMI.
Before you apply, think carefully about why you want to refinance. While refinancing may help you save money, it comes with closing costs that can chip away at the benefits.
It’s also important to note that your lender may have a waiting period — also known as a seasoning period — if you have a conventional mortgage. This is a set amount of time you need to wait before refinancing. You can apply for a refinance with a different lender, but if your current loan has a prepayment penalty for paying off your loan early, you’ll have to pay it. Identifying your "why" behind wanting to refinance can help you weigh the costs and benefits to decide whether it’s worth it.
Read on for the answers to a few frequently asked questions about mortgage refinancing.
How much does refinancing cost?
The average closing costs on a refinance are approximately $5,000, according to Freddie Mac. But the cost of refinancing varies from lender to lender. It also depends on the type of loan you choose, the size of your loan, and where the property is located.
Standard refinancing costs include:
- Loan origination fees
- Government recording costs
- Appraisal fees
- Credit report fees
- Title services
- Tax service fees
- Survey costs
- Attorney fees
- Underwriting fees
What are some benefits of refinancing a mortgage?
Depending on your reasons for refinancing and the type of loan you’re eligible for, refinancing may offer you one or more of the following benefits:
- Lower interest rate — Reducing your interest rate could potentially save you thousands of dollars over the life of your loan.
- Lower monthly payment — A lower interest rate or longer loan term can result in a lower monthly payment. This frees up room in your budget for other living expenses, savings, and investing.
- Shorter loan payoff term — Moving from a 30-year mortgage to a 20- or 15-year mortgage can allow you to pay off your home much faster — sometimes without a significant change to your monthly payments.
- Ability to cash out equity — Tapping your home equity can provide a low-cost way to finance home improvements, college tuition costs, or cover other large expenses.
If you think refinancing is the right move for you, visit Credible to compare mortgage refinance rates without affecting your credit score.
What are some risks of refinancing a mortgage?
Refinancing isn’t the right choice for everyone. Some common risks include:
- High closing costs — Every mortgage involves closing costs. If you focus solely on the interest rate and ignore closing costs, you could wind up paying too much and wiping out the benefits of refinancing at a lower rate.
- Getting underwater on your mortgage — If home values drop after you do a cash-out refinance, you could find yourself underwater on your mortgage. This means you owe more on your mortgage than the home is worth. Being underwater makes it tough to refinance or sell your home.
- Paying more interest over time — When you refinance your 30-year mortgage into a new 30-year mortgage, you start your mortgage term all over again. This might lower your monthly payments, but you could wind up paying more interest in the long run.
- Prepayment penalties — Some mortgages include a prepayment penalty, which is a fee the lender charges if you pay off your mortgage early — usually within three or five years. Before you refinance, be sure to check your paperwork or ask your lender whether a prepayment penalty applies. An unexpected prepayment penalty could offset any savings you’re expecting from refinancing at a lower interest rate.