Mortgage terms can be as lengthy as 15, 25 or even 30 years. A lot can change in that timeframe, so it’s no wonder why homeowners may look into refinancing their mortgage.
Refinancing your home loan can be a financially savvy move, whether interest rates have dropped or your situation has changed, from earning a higher income to needing to free up for your monthly budget for other costs.
In 2022 alone refinanced mortgages totaled $2.8 trillion in the U.S., according to industry data. Through refinancing, borrowers saved $2,700 in mortgage payments, locking in interest rates that were 1.15 percent lower on average than their initial mortgage.
But the process is rigorous. You’re essentially applying for a mortgage all over again, with lenders poring over your income and personal finances along with lengthy closing costs you’ve got to foot the bill for – again.
If you’re thinking about refinancing your mortgage, here’s everything you need to know about the costs, the requirements, and how to get your application across the finish line.
What is mortgage refinancing?
In a nutshell, when you refinance your mortgage, you’re replacing your current home loan with a brand new one. You’ll apply all over again, to set a new loan amount, interest rate, terms, and potentially even a new lender.
Should you refinance your mortgage?
Refinancing your mortgage is a time-consuming – and costly – endeavor. You’ll need to take stock of the advantages and drawbacks before proceeding. The benefits of refinancing your mortgage include:
- Reducing your interest rate
- Shortening your terms to be mortgage-free faster
- Lengthening your terms to reduce monthly payments
- Switching from an adjustable rate to a fixed rate, to lock in a lower interest rate
- Tapping into home equity with a cash-out refinance
Securing a lower interest rate is the biggest draw for refinancing your mortgage. Ideally, you’re aiming for a lower interest rate of about one to two percent.
Lenders may offer you a better interest rate, depending on the market, an improved credit score, or by shortening the terms of your mortgage. This move could save you thousands of dollars over the lifetime of your loan. You’re also spending of your mortgage payments on interest, and putting more towards your principal debt.
If you’re opting for a cash-out refinancing, you’re turning a portion of the home equity you’ve built up over the years into a cash payout to use for home renovations, big ticket purchases like a car or higher education, or to pay off debts.
As a rule of thumb, lenders allow homeowners to borrow up to 80 percent of their home’s market value. You should not tap into your hard-earned home equity for non-essential spending.
It’s worth checking on whether a home equity loan or home equity line of credit is better suited for your needs. Cash-out refinancing tends to be the most expensive option.
How much does mortgage financing cost?
The downside to refinancing your mortgage is the cost, which can account for as much as two percent to six percent of your loan principal, according to industry estimates. That means that if you’re refinancing a mortgage of about $200,000, you could be spending between $4,000 to $10,000 in closing costs alone.
The national average for a single-family property refinancing in 2022 was $2,375, according to a report from ClosingCorp. While this amount excludes recording and specialty taxes, it’s still less than one percent of the average refinance loan amount in the U.S., which is $304,909.
But these costs will vary, depending on where you live. Hawaii, New York, Florida and Texas have the highest closing costs in the country, ranging from $3,370 to as high as $4,730.
Closing costs encapsulate all of the expenses involved with reapplying for a mortgage – your loan origination fees, credit report, property appraisal, attorney fees, and more.
Always check the terms on your existing mortgage in case you’re also responsible for prepayment penalties. This could be a major deterrent, stopping you from applying for a refinance.
You need to decide if refinancing is worth your time and cash by comparing your current interest rate with the new one you’d be securing. Then, add up the total cost of refinancing to see how long it would take for you to recoup your costs through savings made on your new loan.
If you plan on moving before these costs are recouped, refinancing may be a waste of your money – and efforts!
How to refinance your mortgage: a step-by-step guide
Qualifying for a refinanced mortgage takes some legwork before you even get started on the application. Here’s a look at the step-by-step process:
- Understand your credit score and financial situation
Before you begin shopping around for lenders and interest rates, understand what kind of candidate you are for taking out a new mortgage. If you haven’t looked at your credit score lately, now is a good time to do so, pulling your credit reports from the major bureaus in the U.S. (TransUnion, Equifax and Experian).
Review your reports to make sure there aren’t any errors pulling down your score, and determine if you’re in a good financial shape to make your case to lenders.
Mortgage refinance lenders expect your credit score to be at about 620 at minimum, but if you want to score a competitive interest rate, you ought to aim for a credit score of about 750.
- Outline why you’re refinancing and what your new terms would look like
Why are you going through the trouble of refinancing your loan? Perhaps your credit score has improved, you have more income to dedicate to mortgage repayments or you need some wiggle room in your budget and your monthly payments are stifling your cash flow.
Be clear on why you’re refinancing your mortgage and make sure it’s worth the cost in the long run.
You’ll also need to understand precisely what your new loan should look like. Do you want to shorten or lengthen your terms or shift to a fixed or variable interest rate?
You need a clear vision for why you’re refinancing and how your new loan terms will fit into your household’s budget.
- Shop around for lenders
You do not have to return to your current lender to refinance your mortgage. As a free agent, shop around to find the best mortgage refinance rates available to you to try to save money. It is worth your while to start with your current lender to see how they can help you, though.
When you’re shopping for a lender, pay attention to:
- The interest rates they can prequalify you for
- Their minimum credit score and income requirements
- Their estimated time to closing and closing cost expenses
- Their typical loan repayment terms
- Their loan-to-value ratio requirements (for cash-out refinance loans)
- Their fine print, such as prepayment penalties and late payment penalties
- Apply for your new mortgage
Once you’ve set your sights on your top pick, move ahead with the application process. Have documentation ready, such as annual tax returns, pay stubs and other proof of income, such as investments, bank statements, and homeowners’ insurance and title insurance policies.
You’ll need to go through the closing process all over again – that includes a property appraisal, title search, home inspection, and even underwriting on a new loan.
You can try to decrease your closing cost bill. If you’re a long-time, hassle-free client with your lende, ask if they can waive charges such as your application fee or the credit check.
If your first mortgage was just recently brokered, you may even make the case for forgoing the property survey or title search.
- Finalize your loan terms
After the loan application and closing process is complete, you can seal the deal on your new loan. You should have a new loan balance to pay off, terms ranging from 5 to 30 years, and interest rate that’s either fixed or variable.
Mortgage refinancing is common in the United States, and it’s a move homeowners make for a variety of reasons. As long as it’s helping you save cash in the long run, through lower interest rates, better terms or tapping into home equity, it’s a sound financial move.
To pull this off smoothly, your job is to do your homework through the process. For starters, make sure it’s worth the upfront closing costs you’ll need to pay for, check on your credit score to see if lenders will offer you competitive rates, and shop around to find the best deal for your situation.
Also take stock of your long-term plans. If you plan on staying in your home in the long run, you can make up the costs of refinancing over the course of just a few years.
Carmen Chai is an award-winning Canadian journalist who has lived and reported from major cities such as Vancouver, Toronto, London and Paris. For NewHomeSource, Carmen covers a variety of topics, including insurance, mortgages, and more.