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Should I Refinance My Mortgage and When?

TLDR

What You Need To Know

  • Refinancing is usually only worth it if you can lower your interest rate enough to save money over the long term
  • Every loan is different, but lowering your interest rate by even 0.5% could be worthwhile
  • Refinancing can cost anywhere from 3% to 6% of your loan amount, so weigh the costs against the potential savings to see if it makes sense to refinance

Contents

Hey, homeowners, you’ve survived the mortgage process at least once already. And, honestly, there was no better training ground to prepare you to refinance (or refi) your current home loan.

You may be wondering when it would make sense to refinance your mortgage. And if you’re like so many of us, you’re probably coming up with more questions than answers.

It wouldn’t surprise us if you knew that low interest rates, higher home values and opting to make higher monthly mortgage payments over a shorter loan term are all good reasons to refinance.

But you’re not here to learn what you already know.

There are other key factors you’ll need to consider to help you make an informed decision on the timing of your refinance and the cost of refinancing. We can help you assess your situation to determine if refinancing is the right choice – and if you’re doing it at the right time.

Why Should You Refinance Your Mortgage?

The benefits of refinancing your mortgage loan can include helping you reach other money and lifestyle goals sooner. And here are other reasons to consider a refinance:

  • You want to change your loan term: If you need to lower your monthly mortgage payment, you can extend your mortgage term. Shortening your loan term can help you own your home sooner.
  • You want to lower your interest rate: Refinancing to a lower interest rate will lower your monthly mortgage payment and the total amount you’ll pay in interest over the loan’s lifespan.
  • You want to tap into equity or consolidate debt: A cash-out refinance taps into the equity you’ve built in your home. You can use the money to save for retirement, finance home improvement projects or pay off debt.
  • You want to switch from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage: Switching from an ARM to a fixed-rate mortgage keeps your interest rate locked in for the life of the loan. You can switch from a fixed-rate mortgage to an ARM to take advantage of falling interest rates, but that can be risky because the interest rate could go back up, and with it, your monthly mortgage payment.
  • You want to get rid of mortgage insurance: Switching to a different home loan might help you save money by eliminating mortgage insurance and lowering your overall monthly payment.

If you’re wondering how many times you can refinance your mortgage, technically, there is no limit. But there may be waiting periods and other requirements to meet before you can get another refinance approved – like having enough money on hand for closing costs, meeting credit qualifications or waiting to refinance so you don’t trigger prepayment penalties.

Speaking of closing costs and credit qualifications, let’s take a look at three key items you should consider before refinancing your mortgage.

3 Things To Know Before You Refinance Your Mortgage

Make sure you know and understand all the relevant numbers before you refinance your mortgage, from closing costs to your credit score, debt-to-income (DTI) ratio and your new monthly mortgage payment. 

Refinancing can save borrowers money in the long run but may come at an upfront cost. We’d advise breaking out your calculator for this part because you’ll have some number crunching to do.

Know the cost of refinancing

When you bought your home, you probably paid closing costs (also known as settlement costs). It’ll be no different when you refinance.

We’ve broken down the costs and expenses associated with refinancing a loan. The fees include:

  • Home appraisal fees ($300 – $500)
  • Origination fees (up to 1.5% of the loan’s value)
  • Application fees (up to $500)
  • Title search fees and other related title services (upwards of $1,000)
  • Attorney closing fees (depends on your state and local rates)
  • Inspection fees ($200 – $600)

Refinancing can cost anywhere from 3% to 6% of your loan amount, so weigh the costs against the potential savings to see if it makes sense to refinance. The origination fee alone can equal up to 1.5% of the loan amount. And if the equity in your home is less than 20%, you may need to pay mortgage insurance.

Know your FICO® Score and DTI

When you refinance, you swap out your current mortgage with a new loan. That new loan comes with a whole new loan application process, from a new credit inquiry to new closing costs and a new interest rate.

You’ll usually need a credit score of 640 or higher to qualify for a new loan. Generally, the better your credit, the better loan terms you’ll be offered.

If you’ve maintained your credit score or it’s gone up since you got your first mortgage, it can be a good sign that it’s time to refinance. A qualifying credit score signals to a lender that you’ve managed your debt responsibly and can likely make your monthly mortgage payments.

Because the lender will perform a hard inquiry (also known as a hard pull) on your credit report, you will likely experience a dip in your credit score – but it’s temporary. 

For conventional refinance loans, lenders also look at your DTI. That’s a calculation of your total monthly debt as a percentage of your gross income. 

You can use our DTI calculator to calculate your DTI and determine how it might change if you pay off certain debts or increase your income. Ideally, you’ll need a DTI of 36% or lower. Even if your DTI is higher, if you have a higher FICO® Score, you may still qualify to refinance.

Know your LTV to check your equity

Your loan-to-value (LTV) ratio is another key measure in the refinancing process. It looks at the relationship between your current loan balance and the value of your property and helps you figure out your home equity.

The more money you put into paying off your original mortgage and/or the higher your home appraisal value, the more home equity you have. The more equity you have in a home, the smaller the loan you’ll need to apply for. A smaller loan signals to a lender that you are less likely to default on your new mortgage.

In some cases, when you have more than one loan on your home, your combined loan-to-value (CLTV) ratio is used. It’s calculated in the same manner as LTV, but CLTV is the sum of your primary mortgage balance plus any additional loans on the property divided by the current value of the home.

Let’s say your mortgage balance is $150,000, and your home appraisal value is $200,000.

To figure out your LTV, divide the amount you owe by the home appraisal value:

LTV ratio = $150,000 / $200,000 = 0.75, or an LTV of 75%.

Once you’ve calculated your LTV, you’ll know how much equity you have in your home. Equity is the difference between your home’s fair market value (which should be the same as its appraised value) and your current mortgage balance. To calculate your equity, take that difference and divide it by your home’s value.

You can also calculate your home equity by subtracting your LTV from 100%. Using our previous example, if your LTV is 75%, you’d have 25% equity in your home.

Let’s look at the numbers:

  • An LTV of 80% or lower means you’re more likely to be approved for a refi, you’ll get a lower rate and you’ll avoid paying private mortgage insurance (PMI) or mortgage insurance premiums (MIPs).
  • An LTV that’s higher than 80% doesn’t necessarily mean you won’t be approved, but you may end up with a higher interest rate and pay PMI or MIP.
  • Because the combined loan-to-value (CLTV) ratio is a more comprehensive picture of your financial situation than LTV, lenders may be more willing to approve a mortgage with a CLTV that is higher than 80% if you have a high credit score.

Keep in mind that different types of mortgage loans – like Federal Housing Administration (FHA) loans, Department of Veterans Affairs (VA) loans and conventional loans – may have different LTV requirements. An LTV of 80% isn’t a hard-and-fast rule for each loan. Ask your lender or mortgage broker about the LTV rules for each mortgage refinance you’re interested in.

Is Refinancing Worth It?

Refinancing is usually only worth it if you can lower your interest rate enough to save money over the long term. Every loan is different, but lowering your interest rate by even 0.5% could be worthwhile. 

If you’re shopping for a refi, be mindful that a lower interest rate alone does not necessarily equal savings. Closing costs on a refinance can be significant and should not be overlooked because they can quickly negate the savings from your new lower interest rate. 

It may not make sense to refinance your mortgage if you plan on selling in a few years, even if it means lower monthly mortgage payments. Generally, the savings you get from refinancing aren’t instant – they’re earned over time. If you turned right around and sold your home after paying your refinancing closing costs, you may not get to see those savings.

Refinancing with a no-closing-cost mortgage might help with upfront costs if you plan on selling quickly. Your lender will either fold your closing costs into your mortgage balance or you’ll pay a slightly higher interest rate, leaving you with a larger loan principal or a higher interest rate to cover your closing costs.

Here are other important considerations to take into account:

  • Lower monthly payments or a shorter loan term: The amount of time it takes to repay the loan will affect how much you pay out – or save – in interest. The loan’s terms will also factor into how much income you’ll need to comfortably make your monthly mortgage payments.
  • Pay for mortgage points or get a cash-in mortgage to lower your refinance rate: In both cases, you’ll pay a lump sum upfront in exchange for a lower rate. Each mortgage point typically equals 1% of your mortgage amount and lowers your interest rate by 0.25%.
  • Prepayment penalties on the existing mortgage: Check your mortgage agreement or your monthly billing statement for a prepayment clause. Confirm whether you’ll be charged a fee for paying off all or part of your mortgage early. Because a refinance pays off an existing mortgage, it could trigger penalties.
  • If you itemize your taxes, you’ll have less mortgage interest to deduct: It may affect how much money you get back or how much you pay when you file your taxes.

When Is It a Good Time To Refinance?

There is no “refinance season.” Lenders are willing to work with qualified borrowers any time of the year.

But keep in mind that lenders are also busier when rates drop. Lenders may be more willing to consider your application when they have more time.

If rates are lower than when you first purchased your home, you may get a better interest rate than the one you currently have. Even half a percentage point difference in interest can mean thousands of dollars in savings over the life of the mortgage.

One of the most common reasons homeowners refinance is to lower their interest rates. But interest rates shouldn’t be the sole factor that determines whether you refinance or not.

It’s probably a good time to refinance when your credit score is 640 or higher, you have at least 20% equity in your home and current interest rates provide advantages – like lower monthly payments, a shorter repayment term or access to cash through your equity.

How Long Does Refinancing Take?

Though the timeline will vary based on the lender and your situation, most refinance applications take around 30 – 45 days to close. 

Because the application process depends on multiple parties doing their respective jobs, delays are not uncommon. If you submit your paperwork quickly and the lender can get the home inspector and appraiser out within a couple of days, the closing can happen sooner. If the lender, inspector or appraiser isn’t readily available, you’re probably looking at a closing that’s closer to 45 days from start to finish. 

A refinance usually involves nine steps:

  1. Exploring your options by speaking to different lenders
  2. Completing a loan application
  3. Checking your credit report and performing a background check
  4. Receiving a loan estimate
  5. Getting a home inspection and appraisal done
  6. Waiting for the lender to finalize underwriting
  7. Signing a Closing Disclosure (which states that you agree to the terms and conditions of the new loan)
  8. Closing the loan (including paying closing costs)
  9. Making your new mortgage payments

Setting Yourself Up for Refinancing Success

If mortgage refinancing is your goal, take strategic steps now to qualify for favorable mortgage refinance terms. Monitor your credit score and pay off credit card debt, medical bills, student or personal loans and other debts to keep your debt-to-income (DTI) ratio low.

Not enough equity in your home? Make extra mortgage payments to lower your balance and build equity faster. Just be cautious of any prepayment penalties that may be triggered by making extra payments.

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  1. Your credit score is a three-digit number that’s used to predict how likely it is you’ll pay back money you borrowed.
  2. The score generally ranges from 300 (low) to 850 (excellent). It’s calculated by looking at your previous credit history.
  3. You can check your credit report to find the number or use a free credit tool. You can also plug in your best guess.

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  1. myFICO®. “Credit Checks: What are credit inquiries and how do they affect your FICO® Score?” Retrieved December 2021 from https://www.myfico.com/credit-education/credit-reports/credit-checks-and-inquiries

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In Case You Missed It

  1. Refinancing may be worth it if you want to get a lower interest rate, tap into equity, consolidate debt or get a different loan type or term

  2. Using a mortgage calculator can help you figure out if refinancing will put you in a better or worse financial position

  3. Set yourself up for refinancing success by practicing good financial habits like paying off debt and monitoring your credit report

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