Wondering whether you should refinance your mortgage, how to do it and when?
We’ve put together answers to some of the most frequently asked questions about mortgage refinancing.
If you’re a homeowner, refinancing your mortgage is a tool that could save you thousands of dollars. Here’s what you need to know:
Mortgage refinancing is a financial transaction in which you replace your current mortgage with a new one to gain some kind of financial advantage — such as a lower interest rate or a change in the length of your payment terms.
In general, you might consider refinancing your mortgage if you fall into one of these categories:
- You want a lower monthly payment. In this case, you might refinance into a loan term that's equal to or slightly longer than your current term. But recognize that you'll end up paying more interest over the life of the loan.
- You want to get out of debt faster. Refinancing from a 30-year mortgage into a 15-year is a slam dunk for saving money long-term, but your payment will be higher each month.
- You're moving from an adjustable-rate to a fixed-rate mortgage to lock in a lower interest rate.
- You want to pull cash out of the equity in your home with a cash-out refinance (something money expert Clark Howard recommends only in limited circumstances).
Interest rates are at historic lows. If you currently have a rate above 4%, this is a great time to take a look at a refi.
But your decision shouldn't depend only on the rate: It's important to consider how long you plan to stay in your home. Money expert Clark Howard has a rule about break-even costs on refinancing.
We’ll get to an explanation of the associated costs with refinancing in a moment, but first here’s his rule:
So you need to be sure you’ll stay in the house for at least two and a half more years to make up the cost of refinancing. Clark says most people end up staying in a house longer than they anticipate, but just be sure you plan to cross that 30-month threshold.
To get a sense of how much money you’ll save by refinancing your mortgage, you can turn to any of several online calculators.
These calculators will show you exactly what your break-even point will be and how much money you can save over the life of your loan by refinancing:
As you type in your numbers, make sure to take a look at what your monthly payment would be if you refinance into a 15-year mortgage.
Rates on 15-year loans are lower than those on 30-year loans. That’s because they’re a lower risk to lenders since they’ll get their investment back in half the time. The trade-off is that you’ll have a higher monthly payment on a 15-year loan. But if you can swing it, a 15-year mortgage is an opportunity to get out of debt in half the time.
If you can’t afford the payments on a 15-year refi loan, Clark suggests looking at a 20-year refi instead.
You should expect to pay anywhere between 2% to 6% of your loan amount in closing costs to refinance your mortgage, according to LendingTree.
The fees you pay fall into two categories:
- Closing Costs
While exact closing costs vary by state, the average for a single-family home was $5,749 including taxes ($3,339 excluding taxes) in 2019. That's according to ClosingCorp, a leading provider of residential real estate closing cost data.
Closing costs include fees for a lot of things: a property appraisal and pulling your credit report — as well as fees for processing, underwriting, attorneys, notarizing the transaction and title insurance. Depending on where you live, there might be more.
It is possible to refinance without paying closing costs upfront, though you’ll pay a slightly higher interest rate. But you’ll save so much money in the long run if you reduce your loan term. That’s why Clark says no-closing-cost refis can be a win/win.
If you do choose to go the route with closing costs, you'll often have the option to pay those costs upfront or roll them into your new loan.
The consumer champ says the former is a smarter move. “If you’re going to stay in the property for enough years, you want to prepay the closing costs,” notes Clark. “Because otherwise, you’re paying interest every month on the money you rolled into it, so you’re taking away some of the advantage.”
Points are another kind of fee you need to know about. A point represents 1% of the total amount of money borrowed.
There two kinds of points:
- Origination points: This is simply a junk fee to line lenders' pockets.
- Discount points: Money paid in advance to lower the interest rate over the life of a loan.
Clark has a simple rule when it comes to points: Never pay points to buy down your interest rate!
Keep in mind that not every lender charges points — credit unions often don't — so if you can avoid paying points entirely, all the better.
As a result of the coronavirus crisis, many lenders are tightening standards for borrowers. That means you may need a higher credit score to refinance now than you would have last year.
In fact, MarketWatch reports some lenders are insisting on a minimum credit score of 700 to consider a cash-out refinance application.
Of course, that varies by lender. But it's always better to have a higher credit score. We've got advice on how to raise your credit score fast here.
But it isn't necessary to have an 800+ credit score to get a really great offer. As long as you can hit 760, you'll basically get the same kind of offers as people who have top-tier credit, according to Beverly Harzog, a credit card expert and consumer finance analyst for U.S. News & World Report.
"If you can get up to around a 760, you're going to get the same benefits, the same offers, that someone who has an 840 score is going to get," Harzog tells Clark.com.
One of the most common questions we get about refinancing at our Consumer Action Center is, "Which companies are the best to refinance a mortgage?"
Clark points out one place where you shouldn't look — and that's a big bank.
“Banks are so unbelievably inefficient as operations. So the mortgage market is being taken over by non-banks like Quicken Loans and others,” Clark says. “Non-banks run so much more efficiently than banks and can make a nice profit charging less on a mortgage than a giant bureaucratic bank.”
Clark says the first place you should look for a refinance is your local credit union — particularly for shorter-term refis like seven or 10 years.
If you’re not already a member of a credit union, check out their websites to you can see what rates they’re quoting. Or you can call a few around town to figure out which one you might want to join.
Meanwhile, some non-bank online lenders you may want to consider include:
Finally, you may also want to check the Costco mortgage program for refinances.
The bottom line: You’ll likely save thousands of dollars on refinancing your mortgage if you shop around. Clark recommends that you get quotes from at least three different sources.
But don’t fall into the trap of getting hung up on interest rate alone when comparison shopping. The interest rate is the bright, shiny object most people tend to focus on. But it’s only part of how you compare one loan offer to another. You’ve also got to consider points, if any, and closing costs.
When you put the offers side-by-side and compare all three factors — interest rate, closing costs and points — you'll be able to see which is the best deal.
With mortgage rates at record lows, refinancing is a good way to secure a lower interest rate and pay off your housing debt faster with a shorter loan term. Or you can refinance your mortgage to get cash out of your home or move from an adjustable-rate to a fixed-rate mortgage.
If you can’t afford a higher payment on a shorter loan term, you can still refinance into a new, traditional 30-year term with a lower interest rate. Then just pay extra toward the principal each month if you can. By doing that, you’ll get out of debt faster without being tied to a higher payment.
If you have additional questions about refinancing your mortgage, reach out to our Consumer Action Center.