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- Refinancing a mortgage can help you secure a lower mortgage interest rate, reduce your monthly payments, or access some of your home’s equity.
- To qualify for the best rates, you’ll need to have a good credit score. If your credit score is low, you can work on improving it before applying for a refinance.
- When comparing lenders, make sure to consider closing costs and think through how long it will take you to “break even” after refinancing.
- Read more coverage from How to Do Everything: Money
When you refinance a mortgage, you take out a new loan to replace your old one. In many cases, homeowners refinance their mortgage to get a lower interest rate and monthly payment. You can also use a refinance to change the length of your mortgage or access some of your home’s equity.
If you’ve never been through the process of refinancing a mortgage before, you may have no idea where to start. How do you go about refinancing a mortgage and how can you make sure that you’re getting the best deal?
How to refinance a mortgage
1. Check your credit score and report
Your credit score plays a major role in the mortgage interest rate that lenders will offer you. In fact, a difference of only 100 to 150 points could make a big difference.
For example, MyFICO says that borrowers with scores from 620-639 could qualify today for an interest rate of just over 5% for a 30-year mortgage. But borrowers with scores from 700-750 could qualify for rates as low as 3.71%. And a FICO score of 760-850 could earn you a 3.49% rate.
That means your interest rate could improve by 1.3% to 1.5% by simply improving your score 80 to 150 points. And that could make a big difference in your total cost over the life of the loan. For this reason, you’ll want to make sure that your credit is in good shape before you begin the refinancing process.
Check with your bank or credit card issuer to see if they’ll provide your credit score for free. Or you can use a free tool like Credit Karma or Credit Sesame. And you can access your full credit report from all three credit bureaus for free once every 12 months at annaulcreditreport.com.
2. Think through your financial goals
If your credit is in good shape, then it’s time to begin thinking about your refinancing goals.
- Is your primary goal to save on interest?
- Or are you just looking to improve cash flow by lowering your monthly payment?
Your answers to those questions will influence how you approach your mortgage refinance. For instance, let’s say you’ve already made 10 years of payments on your original 30-year mortgage. In that case, you have at least three refinancing options:
- Refinance to a new 15-year mortgage: You’ll have a higher monthly payment, but you’ll pay the least in interest.
- Refinance to a new 20-year mortgage: If you qualify for a lower interest rate, you’ll have a lower monthly payment and will pay less interest overall.
- Refinance to a new 30-year mortgage: In most cases, you’ll have a significantly lower monthly payment, but you’ll pay the most overall in interest.
If saving on interest cost is your primary concern, then you’ll want to choose a loan with a similar or shorter term than what you have now. But if cash flow is your primary concern, a longer term could make sense.
Finally, are you hoping to use some of your home equity to fund a home renovation or some other major expense? If so, then a cash-out refinance could make sense. That’s when the new loan you take out is for more than you owe on your original loan, and you take the difference in cash. But keep in mind that you’ll be adding more debt overall.
3. Get multiple quotes
Once you’ve decided your purpose for refinancing, it’s time to start shopping around for a loan. Make sure to get quotes from at least three qualified lenders.
Worried that getting multiple quotes will hurt your credit score? Don’t be. Many lenders will be able to give you a quote while only performing a soft pull on your credit. In this case, the hard pull wouldn’t come until you decide to move forward with an actual application.
But even if a few hard inquiries hit your credit report, that isn’t something to panic about. Both FICO and VantageScore treat multiple inquiries within the span of 14 days as one inquiry. So get as many quotes as you need to make sure you’re getting the best deal.
4. Pay attention to closing costs
While the mortgage interest rate you’re quoted for a refinance is important, you’ll want to consider closing costs as well. One lender may charge significantly more closing costs than another simply because they throw in a bunch of “junk fees.” Look for terms like application fee, processing fee, underwriting fee, document-preparation fee, or administrative fee.
Ask the lender you’re working with to send you a “loan estimate.” This should give you an idea of what you’ll be expected to pay at the closing table.
Some lenders may advertise “no closing costs” refinances. But keep in mind they may charge higher interest rates in return. You may also have the option to roll your closing costs into the new loan, but know that this will increase interest costs over the life of the loan.
Once you know how much you’ll be charged in closings costs, think about how long it will take you to “break even” on the refinance.
For example, let’s say you’ll save $150 on your monthly payment after refinancing and you’ll pay $4,500 in closing costs. In this example, it would take you 30 months to break even on the loan because it would take that long for your $150 monthly savings to add up to $4,500 overall. If you plan to move earlier than your break-even point, then you may want to hold off on the refinance.
5. Gather the necessary documents
Once you’ve filled out your refinancing application, your loan will enter the underwriting stage. This is when the lender decides if there’s a likely chance you’ll be able to repay the loan.
To make an informed decision, most lenders will ask for various financial documents. At the least, you can expect them to ask for your last two or three tax returns, several recent pay stubs, and three to six months of bank statements.
To help the underwriting process go smoothly, try to gather as many of these documents ahead of time as you can. And if your lender asks for more documentation, get it to them as quickly as possible.
6. Complete a home appraisal
For most mortgage refinances, your home will need to be appraised in order for the loan to be approved. The lender will want to make sure that they’re not lending you more than your home is worth.
Your home’s appraisal will also determine how much equity you can pull out during a cash-out refinance. For example, let’s say that you owe $100,000 on your original mortgage and your home appraises for $200,000. In that case, you have $100,000 of equity in your home.
To access some of that equity, your new loan would need to be larger than $100,000. For example, if you took out a new loan for $150,000, $100,000 would go to pay off your original loan and the other $50,000 would go directly to you. You’ll still be paying off the full $150,000 over the life of the loan, but you can get an injection of cash if you need to make a big repair or fund some other large expense.
7. Close on the new mortgage
Once your loan has passed through the underwriting stage and has received final approval, all that’s left to do is close the loan.
If you’re using a local lender, you may need to drive to their office or to a title company for the closing. Or the lender may send a mobile notary public your way. And, in that case, you’ll be able to sign all the mortgage paperwork from the comfort of your home.
Once all the documents have been signed and closing costs have been paid, your work is done! Moving forward, you’ll send your mortgage payments to your new lender.
The bottom line
Refinancing a mortgage can be a great way to reduce your interest costs, lower your monthly payment, or get your hands on some of your home’s equity.
But refinancing won’t be right for everyone – especially if you have damaged credit or plan to move soon. Before you go through with a mortgage refinance, make sure the numbers make sense. And be sure to shop around for the best deal.