Whenever I’ve complained about my mortgage interest rate my mom has reminded me that when she and my dad bought their first house their interest rate was 16%—a far cry above today’s average mortgage rates. When they eventually refinanced to 7%, she said, it was like bringing in an additional income every month. And while today’s rates might not be nearly as high as they were 30 years ago, it’s still true that a mortgage refinance can put a considerable amount of money back in your pocket month after month, and can also be a great way to build equity faster in your home.
I’ve done a mortgage refinance on my home twice since purchasing it in August 2018, in the process savings hundreds of dollars in interest each month that I’ve been able to put into other things—including my principal. Read on to learn about the basics of mortgage refinancing, from what it means in the first place to why it might be worth pursuing even if you already have a decent rate.
What is a Mortgage Refinance?
A mortgage refinance is when you transfer the loan on your house to a new mortgage with new rates. The new mortgage pays off the balance on the previous one, allowing you to take advantage of better terms and interest rates without a disruption in lending.
Some of the reasons that people choose to do a mortgage refinance are:
- To lower interest rates
- To move from a variable interest loan rate to a fixed interest loan rate
- To reduce monthly payments
- To switch to a new mortgage provider
- To cash out home equity
- To get rid of private mortgage insurance (PMI)
A new survey by Bankrate, a consumer financial services company, found that 7 out of 10 mortgage holders are either paying more than the average mortgage rate or don’t know what their rate is at all. Among respondents, the average interest rate was 4.41% (0.71% above the national average of 3.7%). With a mortgage refinance, these homeowners would be able to take control of their interest rate and take advantage of today’s record lows.
How Much Does a Mortgage Refinance Cost?
You’ll have to pay closing costs on your refinanced mortgage just like you did on your previous mortgage, with a nationwide average of around $2,000—or about 3% to 6% of the total loan amount.
The cost of a mortgage refinance varies depending on a few key factors, including your credit score, the loan amount, and who you’re borrowing from. Here’s how the closing costs for a mortgage refinance break down, according to LendingTree:
Loan application/origination fee – 0% to 1.5% of the loan balance
Underwriting fee – 1% of the loan balance
Home appraisal fee – $300 to $500 for a single family home, $600+ for a multi-family home
Yield-spread premium – 0.25% to 1% of the loan balance
Title insurance fee – 0.5% of the loan balance
Credit report fee – $30 to $100
Pre-payment penalty fee – Varies by lender, but generally about one to six months’ worth of interest or a set percentage of the remaining balance on the principal of the loan. Pre-payment penalty fees come into effect when loans are paid off early, usually three to five years after they were first taken out. However, not all lenders charge this fee.
Discount points – You’ll have the option of paying for discount points, also referred to as mortgage points, with one point equaling 1% of your loan balance. Discount points lower your monthly payment and make you eligible for a lower interest rate.
Note that closing costs for a mortgage refinance will look a bit different if you are a veteran who purchased your home through a VA loan. You can learn about the refinancing process for VA loans here.
Talk to your lender to see if you qualify for a no-closing-cost mortgage refinance, which allows you to fold the closing costs associated with refinancing into your loan amount in return for a slightly higher interest rate. Some mortgage companies will also offer incentives to keep you as a customer instead of having you switch to another provider, such as removing the requirement for a new appraisal.
So, Should You Refinance?
Whether or not it’s a smart idea to undertake a mortgage refinance will depend on your current loan situation, your refinancing options, and how the associated closing costs compare to what you’re spending each month. To the latter point, it’s important that your closing costs don’t offset the savings that you get from lowering your interest rate. Use a refinancing calculator to get an estimate of what you might be able to expect.
A mortgage refinance isn’t a guarantee of a lower interest rate. Do plenty of research—and ask your lender plenty of questions—to ensure that the terms and rates on the new mortgage are going to be preferable to your current mortgage. You may want to consider working with a mortgage broker as well. While their services aren’t free, they’ll be able to walk you through what you need to know in order to decide whether a mortgage refinance is a good way to go, and can help ensure that you come out with the best terms and rates.
Other Options to Consider
A mortgage refinance isn’t the only way to rearrange your funds and get more money in the bank. If your primary reason for pursuing a refinance is to cash on your investment then consider these options as well:
Second mortgage
A second mortgage is an additional loan that you take out on your home and that is secured by your equity from the first mortgage. You’ll get the money in a lump sum, which you can then use for a variety of purposes, including home improvements, college tuition, or putting more money into your original loan. The amount that you can take out depends on how much equity you currently have in your home, as well as the market value of the property. And since your home is serving as collateral, you can often get a lower interest rate with a second mortgage than you can with other refinancing options.
Home equity line of credit (HELOC)
Similar to a second mortgage, a home equity line of credit, often shortened just to HELOC, is a second loan that you take out from the equity that you have on your property. There’s usually a standard 10 year draw period during which you can take out funds from that amount, followed by 20 years for repayment. Think of it like a credit card, with an available balance that you can utilize as you see fit. HELOCs generally have lower interest rates and more variable terms than conventional loans.
Both of these options come with their own terms and closing costs, so just as you would do for a mortgage refinance be sure to look over all of the details so you can make sure you’re putting your home investment to good use.
How to Get Started with a Mortgage Refinance
If you’ve run the numbers and decided that a mortgage refinance is a great option for your current and long-term financial situation, then follow the steps below to lock it into place.
Research to Find the Best Rates
Any interest rate that is below what you are currently paying is a win, but within that group there will usually still be some degree of variability. Do plenty of digging, and shop around for the best rates instead of just opting for the first one that seems favorable.
Apply for the New Mortgage
A mortgage refinance isn’t a guarantee; you’ll have to apply with lenders to make sure that you’re eligible. It’s a good idea to apply for refinancing with three to five different lenders, but be sure that you do it all within a limited period (about two weeks) so that you don’t hurt your credit score.
Compare
Once you’ve gotten the go-ahead from lenders, compare the Loan Estimates that you receive from each so that you can see who’s offering the most favorable terms and rates with the lowest closing costs.
Lock In Your Rate
It takes about 30 to 45 days for a mortgage refinancing to be completed, and a lot can happen with interest rates during that time. Lock in your rate with the lender that you chose so that when your new mortgage is ready to go into effect you get the same rate that you anticipated when you applied.
Close on Your New Mortgage
Remember all of that paperwork you signed with your original mortgage? Yeah, you’ll have to do it all again. Everything will be pretty much the same, and you’ll have someone there to walk you through what you’re signing.
Think a mortgage refinance is the way to go? Don’t waste time. Act fast to take advantage of current rates and get the ball rolling.
