If you have a mortgage and are considering refinancing (or “refi”), you’ve probably seen all of the marketing around taking advantage of refi rates, saving a lot of money, or taking advantage of “cash-out refinance” programs. But is there really an opportunity to save money on your mortgage by refinancing? We’ll walk through all about why people refinance, the pros and cons, and what to look out for to determine if mortgage refinance is the right move for you.
What is Mortgage Refinance?
Refinancing a mortgage is when a homeowner initiates a new loan that replaces the original mortgage with updated rates and terms. The goal, of course, is to claim better rates and terms than what you initially received with your mortgage.
Reasons Why Homeowners Refinance Their Mortgage
There are many different reasons why a homeowner may choose to refinance. It’s essential to be knowledgeable about how the process works, so you can determine when and why to refinance without falling victim to marketing influence.
- Dropping Interest Rates
If interest rates have dropped significantly since you took out your initial home loan, you may be able to save a substantial amount by refinancing and locking in the lower current rate. - Locking in an Interest Rate, Dropping an ARM
Similar to if rates are dropping, you may want to ditch an adjustable-rate mortgage (ARM) if interest rates are low. Switching to a fixed-rate mortgage can allow you to lock in a good rate before they rise again. - Improved Credit and Financial State
If you’ve made significant gains in your financial wellbeing since initiating your mortgage, you may be eligible for better rates and terms. - Changing Your Loan Term
Many homeowners choose to refinance to either shorten or extend their mortgage term. If you shorten your term – for instance, refinancing from a 30-year to a 15-year – you can save a lot of money in the long run. We recommend against refinancing to extend your term unless there are extreme circumstances, as this can be quite costly over time. - Cash-Out Refinancing
Refinancing can give homeowners extra cash if they borrow more than the remaining balance on their mortgage. This is done by tapping into the equity of the home, which enables some homeowners to be approved for this type of loan.Cash-out refinancing can be a good option if you are in need of money for home renovations or other reasons and looking to refinance for one of the above reasons as well. Just be careful not to fall into the temptation of the extra cash if you don’t truly need it.
Should You Refinance Your Mortgage?
Whether or not you should refinance is heavily dependent on your unique situation. All of the reasons above can be strong indicators that refinancing could be a good option.
However, there are costs involved with refinancing and many details that you should think through before making that commitment. As with any significant financial decision, it’s crucial to not be impulsive.
Let’s take a look at some pros and cons of refinancing, a list of those things to think through, and balancing the estimated savings against your anticipated cost.
Pros and Cons of Mortgage Refinance
| Pros | Cons |
|---|---|
| Ability to lock in a lower interest rate if rates have dropped Adjust your loan term to make payments more comfortable or accelerated for cost savings Potentially have the option for cash-out refinancing | Required to pay additional closing costs and fees Temptation for cash-out refi and lowering monthly payments can be harmful in the long run Savings for a lower rate may be less impactful than they seem initially |
What to Consider When Refinancing a Mortgage
Given all of the points above, there are several things you’ll need to consider when it comes to refinancing.
- Your Current Mortgage vs. The Market
Compare how the current market stacks up against your existing mortgage. Are the current rates low enough to truly save you money after closing costs and fees? - Loan Term
Are you able to shorten the term of your mortgage? This will lessen the interest paid over the loan and expedite the path to paying off your mortgage. However, this will likely lead to larger monthly payments. - Mortgage Points
Calculate your potential savings by considering pre-paying interest through mortgage points. You may have the option to purchase a lower interest rate when you refinance. One “point” is equal to one percent of the loan amount – so one point on a $100,000 loan will equal $1,000.It’s important to keep in mind that you’re not paying less interest necessarily – think of it more as pre-paying the interest. There are of course pros and cons to using points, so be sure to do the math first and consider your options.
How Much Does it Cost to Refinance a Mortgage?
The average closing cost required in refinancing a mortgage is about $5,000. [1] This of course, will vary by several factors including the amount of your loan and your location, but you can expect about 3-6% of your loan amount to be required for closing costs.
When working through this process, you’ll want to make sure that the savings you’ll get by choosing to refinance outweigh the cost of refinancing or provide other needed benefits to your personal financial situation.
Mortgage Refinance Process - Step By Step
Now that you know when and why homeowners should consider refinancing their mortgage, let’s boil it down to a step by step process.
- Determine Your Goal and Reason
First and foremost, you need to think about why you are considering refinancing. To make payments more manageable? To lock in a lower rate? To take advantage of cash-out refi programs for renovation costs? - Shop Around to Secure the Best Rates and Terms
If you choose to refinance, be sure to make it count and do your research to maximize your savings. - Apply & Choose a Lender
When you find a few lenders that look promising, be sure to apply within a short time frame to minimize the impact on your credit. Once you’ve reviewed your options, you can select the lender that best helps to accomplish your goals. - Lock Your Mortgage Refi Rate
Locking in your interest rate ahead of closing will guarantee that rate is kept assuming you close on the loan before the rate lock reaches its expiration date. - Underwriting & Approval
After submitting all of the needed documents to the lender of your choosing, the underwriting process will begin as the details of your loan are finalized. Then, you’ll receive the final approval and be ready to close the loan. - Close on the Loan
Finalize your mortgage refinance. This is when you’ll be paying closing costs and finalizing all necessary paperwork.