You may have heard the phrase: “Marry the home, date the rate.” This means that if you buy a house when mortgage rates are high, you can refinance it when interest rates fall.
According to Redfin, around 86% of homeowners with mortgages have interest rates below 6%. As refinance mortgage rates have skyrocketed above 6% over the last two years, most homeowners haven’t seen a financial benefit to swapping out their current home loan for a new one, causing a phenomenon called “the lock-in effect.” Instead of selling and buying a house at a higher rate, homeowners are staying put.
Yet with mortgage rates forecasted to gradually fall over the next two years, more homeowners will be able to take advantage of refinancing.
“The question is, at what rate will the floodgates open? My guess is 5.5%,” said Melissa Cohn, regional vice president at William Raveis Mortgage and member of CNET Money’s expert review board.
That said, there won’t be another refinancing boom like the one we witnessed in 2020 and 2021 when mortgage rates were around 2 to 3%.
Refinancing a mortgage may also make sense under other circumstances, including changing the type of mortgage or removing someone from the mortgage.
Whether you’re looking to tap into your home’s equity, shorten your home loan’s term or lock in a lower interest rate for a more affordable monthly payment, here’s how to decide if and when you should refinance your mortgage.
How mortgage refinancing works
For most people, the primary objective of refinancing a mortgage loan is to lock in a lower interest rate and save money with a smaller monthly mortgage payment.
Another popular reason to refinance is to switch the type of mortgage you have, like changing from an adjustable-rate mortgage to a fixed-rate mortgage.
When you refinance, a new home loan replaces your existing mortgage. Just like getting a mortgage, you’ll need to apply for a loan, have a home appraisal and pay closing costs. The main difference is that instead of shopping for a new house, you’ll keep your current home.
Similar to when you first bought your home, the mortgage refinancing process also involves a lot of paperwork, credit and financial checks and closing costs. Although a new refinance loan is slightly less complicated than an initial mortgage, a mortgage refinance can still take between 30 to 45 days to complete.
Two main options for refinancing
You have two basic options when refinancing a mortgage: a rate-and-term refinance or a cash-out refinance.
A rate-and-term refinance alters the interest rate or term (or sometimes both) of an existing mortgage, and equity isn’t taken out of the home.
With a cash-out refinance, you’re getting a new loan that’s worth more than what you owe on your initial mortgage and pulling out equity. The difference is paid to you in cash.
When it makes sense to refinance your mortgage
A general rule of thumb is that it makes financial sense to refinance your mortgage if you can secure a rate that’s at least 1% lower than the one you currently have.
During the pandemic, mortgage interest rates hit historic lows and a rush of homeowners were able to refinance with lower interest rates. The refinancing boom ended in 2022 when mortgage rates began to surge. Most homeowners had either already refinanced or would no longer be able to get lower interest rates by taking out a new home loan.
Mortgage rates are expected to gradually fall over the course of the next year, moving closer to 6% and below. That opens the door to those with mortgage rates of 7% and higher.
What to know before refinancing
There are many factors you’ll want to consider before you refinance a mortgage.
You’ll need to have enough equity in your home, typically at least 20% to qualify for a refinance. Additionally, mortgage refinancing can run you thousands of dollars in closing costs. Because of this, you want to make sure you’ll be in the home long enough to recoup those costs.
Other reasons to refinance
Refinancing isn’t just about interest rates. If you plan to refinance a mortgage, it’s important to consider both your short-term and long-term goals, said Shelby McDaniels of Chase Home Lending. Here are some other reasons you may want or need to refinance:
- You want to switch from an ARM to a fixed-rate mortgage: If you have an adjustable-rate loan that’s about to have a rate increase, you may consider refinancing to a fixed-rate loan to avoid the risk of future rate hikes.
- You want to eliminate mortgage insurance on an FHA loan: Regardless of your down payment size, FHA loans require you to pay mortgage insurance for the entire life of your home loan. One way to get rid of it is to refinance to a conventional loan once you have 20% equity in the property.
- You want to change the length of your loan term: Refinancing to a longer loan term (for example, from a 15-year mortgage to a 30-year mortgage) can lower your monthly payment, though it will require paying more in interest over the life of the loan. Conversely, shortening your loan term with a refinance may raise your monthly payments, but you’ll save on interest in the long run and build equity in your home faster.
- You want to tap into your home equity: You can use a cash-out refinance to leverage the equity you’ve built in your home and get cash to help cover a large expense. Just keep in mind that a cash-out refi replaces your current mortgage rate with a new rate — one that will likely be higher than what you currently have. You may be better off considering home equity loans and home equity lines of credit (HELOCs).
- Your credit score has improved: Your credit score is one of the main factors that determines what mortgage rate you qualify for. If you have a higher credit score now than when you first took out your mortgage, you might refinance to score a lower interest rate than what you currently have.
- You need to take someone off the mortgage: If you need to remove someone’s name from a mortgage in the case of a divorce or another circumstance, refinancing is the most common route. You’ll apply for a new home loan just in your name (you’ll have to qualify based on your income and credit score only) and use the funds to pay off the current mortgage.
When it doesn’t make sense to refinance your mortgage
Regardless of what’s going on in the housing market, experts say refinancing isn’t a good idea in some situations. If it won’t save you money in the long run, or you’re planning on moving soon, refinancing could put you further behind on your financial goals, said Sean Casterline, president of Delta Capital Management.
- You can’t get a lower interest rate: If your goal is to reduce your interest costs but your mortgage rate is lower than current market rates, right now isn’t the best time to refinance. You’re likely to end up with a higher rate, plus you’ll need to cover closing costs on your new mortgage. If you can hold off, mortgage interest rates are expected to slowly trend down over the next couple of years.
- You’re planning on moving soon: If you’re planning on moving in the next few years, a refinance probably won’t save you money. Even if you can score a lower interest rate, it can take years of lower monthly payments to recoup the money you’d spend on closing costs.
- You’re almost done paying off your mortgage: If you’ve paid off the majority of your original mortgage, it’s worth sticking it out with your existing home loan or refinancing to a shorter repayment term to meet your goals. That’s because once you refinance, you’re starting over with a new loan and term that can cost you significantly more in interest charges.
What to do before refinancing your mortgage
If you’ve determined it’s the right time to refinance, start by figuring out what type of refinance loan you need. Then look at a few different types of banks and credit unions. To accurately compare the refinance rates and fees between lenders, you’ll need to submit an application to receive a loan estimate from each one. Here’s what to do before refinancing to make the process as smooth as possible:
Assess your finances
Before you pursue refinancing, make sure you know where your finances stand. When deciding whether you qualify for a new home loan (and at what interest rate), lenders will look carefully at your credit score, income and what additional debts you have. If your credit score has taken a hit since you took out your initial mortgage, for instance, it may be worth taking some time to boost that number. This is also a good time to explore whether you have the funds to cover the cost of refinancing, which we’ll explore in more detail below.
Research rates
Because the goal of refinancing for most people is to get a lower interest rate, it’s important to monitor when interest rates drop. While many lenders advertise sample rates available to borrowers with excellent credit, that research can still give you a good idea of what the going rates generally are. Some lenders also offer personalized rate quotes based on credit score and other personal information, without a hard credit check.
Factor in refinancing costs
When you refinance your mortgage, you won’t have to make a large down payment, but you’ll still have to pay closing costs. Refinance closing costs are usually around $5,000 according to Freddie Mac, but could be higher based on the size of your new loan balance.
You can choose to pay those costs upfront or roll them into your new loan with what’s called a no-closing-cost refinance. A no-closing-cost refinance is a bit of a misnomer: You’re still responsible for the fees, you’re just paying them over the life of the loan with interest. So if you can afford it, it’s less expensive to pay those costs upfront.
The specific fees can differ depending on factors, such as where your home is located or the type of refinance you’re getting, but can include:
- Loan origination fee
- Appraisal fee
- Application fee
- Credit report fee
- Title insurance
- Discount points
Calculate your break-even point
The break-even point of a mortgage refinance is when the money you save is equal to what you paid in upfront closing costs. Before you pay thousands of dollars to refinance a mortgage, do the math first. Use a mortgage calculator or ask your lender to help you.
Here’s an example of how to find the break-even point:
Let’s say you were able to lower your mortgage payment by $250 a month, but it cost you $6,000 to refinance. To determine how many months it will take until you break even, divide the cost of refinancing by your monthly savings. Using the above figures, the calculation looks like this:
$6,000 / $250 = 24
In this case, you would hit your break-even point in 24 months (two years). If you plan to sell in two years or less, you won’t make back the money you paid in closing costs from the savings on your monthly payments.
Consider the best time to refinance
The best time to refinance depends on your personal circumstances, like how long you plan to stay in your home or how much left you have to go on your mortgage. It can take several years to recoup the cost of refinancing through your monthly savings.
Deciding when to refinance can also depend on factors out of your control, like mortgage rate trends. That’s why it’s so important to research rates ahead of applying. If interest rates are on the rise, for instance, it may be a good idea to wait until they come down again.
How to refinance your home loan
- Apply for a refinance loan: This is the most labor-intensive stage of the process. You’ll need to gather your financial documents — bank statements, pay stubs and your last couple of years of tax returns. You’ll work with the lender closely at this stage to address your credit history, income and debts.
- Lock your rate: Once you get the good news that your refinance is conditionally approved and the process is moving forward, you may be asked if you’d like to lock in the current interest rate, which guarantees your rate won’t change before closing. However, since refinancing rates always fluctuate, it’s hard to predict if rates will be higher or lower at closing than the rate you locked in. If you’re happy with the new payment amount based on the current interest rate, locking your rate could offer you peace of mind throughout the process.
- Underwriting starts: The underwriting process happens behind the scenes. There’s not much for you to do except respond promptly if the underwriter requests more information from you. The lender will verify your financials and property details, as well as conduct a refinance appraisal that will set the new value of your home. The appraisal is an important part of this process since your home’s value will determine how much you can cash out and whether you have to pay private mortgage insurance.
- Close on your new mortgage: Once the underwriting is over, you’ll be ready to close on your refinance. You’ll receive a closing disclosure a few days before to carefully review. The disclosure breaks down all the details of the loans including final closing costs, interest rates, payment amounts and more. You’ll review all the information again at the close and sign all the refinance documents.
The bottom line
No one can tell you how to decide if you should refinance your mortgage. As with any major decision, pursuing a mortgage refinance depends on your financial situation and goals. If you can get a lower interest rate and significantly reduce your monthly mortgage payment, then a refi is worth exploring. Just make sure you also have a good credit score as well as a steady household income in order to qualify. If you’re still not sure, give your lender a call and discuss whether you could benefit from refinancing.
More mortgage resources
FAQs
How long does it take to refinance a loan?
Refinancing typically takes between 30 and 45 days, from the start of the application to closing on the loan.
What is a cash-out refinance?
A cash-out refinance is when you pay off your current mortgage by getting a new one that’s larger than what you currently owe and get a check for the difference. It’s one of the common ways of tapping into your home equity for cash access, along with a home equity loan and home equity line of credit (HELOC).
As an example, if your home is worth $250,000 and you have $100,000 left on your mortgage, that means you have $150,000 in equity. With a cash-out refi, you take out a portion of your home equity and add that onto your new mortgage principal. Most lenders will let you draw out no more than 80% of your property’s value. In this example, that would be $200,000. That would leave you with a $100,000 payout (minus any fees or closing costs) and a new home loan balance of $200,000.
Since you’re refinancing, you’ll also get a new interest rate and loan term. This likely means you’ll extend your mortgage repayment term unless you refinance to a shorter term.
