How to refinance your mortgage

Refinancing your mortgage can save you money in the long term, but the up-front costs could cancel out any savings or push them too far out to make a difference.

Zack Sigel 1600

Zack Sigel

Published October 4, 2019

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  • Refinancing your mortgage means taking out a new mortgage to pay off your old one

  • While refinancing can result in a lower APR, you will may have to pay expensive closing costs

  • Because of the closing costs, a refi might not provide savings for a very long time, which is called the break-even point

  • If your mortgage is unaffordable, it might make sense to sell your home and downsize instead of refinancing

When you refinance your mortgage, you’re paying off your old loan (the mortgage) using a new loan (the refinance) with better terms.

Generally, when you refinance your home, you agree to either a more favorable interest rate or a shorter term. You can also receive a part of your home’s equity as cash. Sometimes, refinancing means lower mortgage payments, but refinancing can also increase your mortgage payments.

Refinancing your mortgage can save you money in the long term, but the up-front costs could cancel out any savings or push them too far out to make a difference. However, if your credit has improved since you originally took out your mortgage, or you make considerably more money, or if your home has increased in value, then refinancing may make sense for you.

Read on:

Benefits of refinancing your mortgage

Before you decide whether to refinance your mortgage, take a look at your credit. If your credit score has increased since you first took out the mortgage, then you might be a candidate for a refi.

You should also calculate your debt-to-income ratio, which measures how much of your debt can be covered by your current income. If your debt-to-income ratio is more favorable than it was the at the beginning of your mortgage, then it might be a good time to refinance.

Look for a lender who offers rates that you can afford. But keep in mind that you’ll also have to pay closing costs just like you did when you originally took out your mortgage, and these may make refinancing less cost-effective.

But there are a lot of good reasons to consider refinancing, including some of the following.

You can get a lower interest rate

If your finances have improved, you may find that lenders are willing to offer you a lower interest rate. For example, say that you’ve been paying off your 30-year, fixed-rate mortgage for 10 years and still have $250,000 to go at a 5.0% interest rate.

If you refinance to a new 30-year, fixed-rate $200,000 loan and get a 4.8% interest rate, you’ll save $72,368 over the lifetime of the loan, accounting for about $6,000 in fees. However, it will take you almost 20 years to break even over simply paying off the original loan.

While paying a lower interest rate can save you tens to even hundreds of thousands of dollars by the time the refinanced mortgage is paid off, you need to take closing costs into consideration. As with your original mortgage, you’ll need to pay a number of certain fees, which could be prohibitively expensive.

Use the Policygenius Mortgage Calculator to see how much you can save from refinancing your home loan.

You want to get rid of private mortgage insurance

Lenders require you to pay mortgage insurance premiums in additional to your monthly mortgage payments if you made a down payment of less than 20% at signing. Refinancing is the only way to lose these costly premiums. In order to be eligible, you must have gained at least 20% equity on your home.

You want to convert your mortgage

Refinancing allows you to convert from one type of mortgage to another. That could mean going from a fixed-rate mortgage to an adjustable-rate mortgage (ARM) or from an ARM to a fixed-rate mortgage. You might want to switch to a fixed rate if your ARM’s interest rates keep increasing; you might want to switch to an ARM if your fixed-rate mortgage’s interest rates are higher than market rates.

You want to pay the mortgage off faster

You can refinance your mortgage from one term to another. If you switch to a shorter-term mortgage, like going from a 30-year to a 15-year, you may have to pay higher premiums because you’re paying the principal off faster. (While 30-year mortgages are the most common type, you can generally ask your lender for any term length.)

Note that you don’t get back the years you spent paying off the original mortgage. The refinance term starts the clock at year 0.

You need cash

We’ll go into the cash-out refinance later, but the gist of it is that you can tack on a part of your home’s equity to the new loan amount and receive it as cash. While this will increase the amount of principal you have to pay over time, it could help you get out of a short-term bind.

How much does it cost to refinance?

A major argument against refinancing is that it has a lot of the same closing costs that your original mortgage had. Because these costs can reach into the thousands of dollars, for some people they may offset the benefits of refinancing too much to make it work. Refinancing closing costs are estimated to be as high as 6% of the loan amount.

Some of the fees involved in a refinance include:

  • Application and processing fee
  • Credit check fee
  • Loan origination fees, including the title search fee, and any points
  • Underwriting fees
  • Taxes

While some lenders may offer a no-fee refinance, in general they mean no fees up front. These costs will still be rolled into your monthly mortgage payments

How do I refinance?

To refinance, first shop around for the lender who has the most agreeable rates. You can also ask about their closing costs, although certain costs will vary between people of different financial backgrounds. You don’t need to use the same lender who wrote your original mortgage and there may not be any benefit to doing so if you can get a better deal elsewhere.

Next, try to figure out the value of your home. If your home has increased in value, you could be eligible for more favorable refinancing terms. This will help you figure out how much equity your home has. Take how much of your mortgage balance remains and subtract it from the current market value of the home to figure out how much equity you have.

Now, it’s time to apply. You’ll find the steps familiar from applying for a mortgage:

  • 1. Get prequalified.
  • 2. Compile your documentation, including financial information and tax forms.
  • 3. Apply.
  • 4. Get processed and go through underwriting.
  • 5. Receive closing disclosure document and sign the agreement.

When not to refinance

While refinancing can help you save money or pay down a mortgage faster, it’s actually most useful for people who are already keeping ahead of their payments and have strong financials. People whose finances haven’t improved since taking out their original mortgage or who are struggling to repay their mortgages won’t benefit as much and may even lose money on a refinance.

Some reasons not to refinance include:

You don’t want to tack on additional mortgage period

Refinancing your mortgage means taking out a whole new loan. Sometimes, this means getting a shorter term than your original mortgage, but it can also mean having the same term or even extending it. If you plan to stay in your home for a long time, you may not want to be paying an additional 30 years’ worth of mortgage.

You want to pay less interest but can’t afford higher payments

If you refinance to get a shorter term, you could pay less interest over the period of loan. However, this means that your monthly payments could increase to make up for the shorter length of time you have to pay off the principal.

Your home’s value has increased and you want to downsize

With a refinance, your old mortgage gets paid off and you reap the benefits over the period of the new loan. But you might be able to sell your current home and downsize to a new one, which would let you pay off your old mortgage with the proceeds and pocket any of the profits.

You’re struggling to repay your mortgage

There are a lot of reasons why someone might fall behind on their mortgage payments. For example, you may have had to cover other unexpected expenses, or your income may have dropped. In this case, it may be impossible to receive a refi in the first place because banks will want to see your debt-to-income ratio and credit. Additionally, you’ll need liquid cash that you may not have to cover refi’s closing costs.

Cash-out refinance: pros and cons

A cash-out refinance is kind of like a home equity loan in that you receive a part of your home equity as cash and have to pay it back over a period of time. Like a rate-and-term refinance, you could get a shorter or longer term, or lower interest rates, as well as a lot of cash. This cash can help you make repairs to the home, pay for important expenses, or consolidate your debt under a single monthly payment.

To determine whether a cash-out refinance is right for you, first you need to figure out how much equity you have on your home. If your home was $200,000 when you purchased it, but it is now worth $250,000, and you’ve paid $100,000 toward the mortgage, then you have $150,000 in equity.

You can’t receive the full $150,000 from a cash-out refinance, but you may be able to receive a large part of it. So say you want $100,000. With a cash-out refinance, you add that amount to the portion of the remaining mortgage balance, and you now have a $200,000 mortgage.

You may be eligible for lower interest rates if your credit and debt-to-income ratio have improved. However, you may still have to pay higher interest over time, since the result of the cash-out refinance is a higher mortgage balance. You could even end up spending more interest than you would have had you just paid off your original mortgage. If you do go for a cash-out refinance, make sure to take out only what you need.

The cash-out refinance could leave you with less equity than you had prior to taking it out. That could make your home harder to sell at a profit later down the line. Additionally, you’ll still have to pay closing costs, which could eat into the cash you’re meant to receive. You’ll also be on the hook for private mortgage insurance if the new mortgage amount exceeds 80% of your home’s value, which is called the loan-to-value ratio.

Refinancing with low equity using HARP

The Home Affordable Refinancing Program, or HARP, emerged from the financial crisis to allow homeowners to refinance their homes when they owe more on a mortgage than their home is worth. While HARP can’t reduce how much you owe on the mortgage principal, you may be able to receive a lower interest rate and thus reduce your monthly payments.

According to the HARP website, you must meet the following conditions to be eligible:

  • Your mortgage was originated on or before May 31, 2009.
  • Your mortgage is guaranteed or owned by Freddie Mac or Fannie Mae.
  • Your home’s loan-to-value ratio exceeds 80%.
  • You’re up to date on your mortgage payments, with no more than one late payment in the last year and none in the last six months that were later than 30 days.

Originally, HARP was meant to sunset on December 31, 2016. However, it has since been extended twice: first, until September 30, 2017, and next until December 31, 2018. As of October 2018, HARP is still scheduled to expire at the end of the year.

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