In 2021, millions of people rushed to refinance their mortgages to take advantage of historically low interest rates. In fact, Freddie Mac reported that there was a 33% increase in refinancing in the first half of 2021 compared to the first half of 2020.
However, refinancing may not seem as wise a move as it was just a few months ago. As of April 12, 2022, the average rate on a 30-year, fixed-rate mortgage was 4.67%. That’s a 1.45% increase from the January average rate of 3.22%. If you’ve been watching interest rates climb, you may be wondering if it’s too late to refinance your mortgage.
While rates are higher than they’ve been in quite some time, that doesn’t necessarily mean it’s a bad time to refinance. In fact, according to Freddie Mac, 24% of homeowners plan on refinancing their mortgage within the next six months. Let’s take a look at a few reasons you might want to consider refinancing your mortgage now.
Reasons to refinance your mortgage
A homeowner may consider refinancing their mortgage for several reasons. They might want to save money or want to access equity they’ve accumulated to pay for a large expense. Here are some common reasons for refinancing a mortgage.
Lower your monthly mortgage payment
When you took out your existing mortgage to buy your home, you may have gotten a higher interest rate than you wanted. This could be because you had poor credit or a short credit history or just because rates were higher at the time.
If your credit and income have improved since then, you could potentially qualify for a lower rate than you have by refinancing your home loan. You can also change your loan term. With those two changes, you could significantly reduce your monthly payments.
According to Freddie Mac, those who refinanced their mortgages during the first half of 2021 saved an average of $2,800 annually in mortgage payments. That’s a lot of money you’d save every month that you could put toward other goals, like your retirement fund.
Save money over the life of your loan
One of the main reasons to refinance your mortgage is to lower your monthly payments. By refinancing your loan, you could qualify for a lower interest rate than you currently have. With a lower rate, less interest will accrue, saving thousands of dollars over the length of your repayment term.
For example, let’s say you took out a $200,000 loan in 2008 and qualified for a mortgage with a 30-year term and a 6.2% interest rate. If you refinanced your mortgage this month and qualified for a 15-year loan at 4.67% interest, you’d save $23,000 by the end of your repayment term.
Get cash for home renovations or other major expenses
If you have a major expense coming up, such as a kitchen remodel or your child’s college education, you can use a cash-out mortgage refinance to get money upfront. With a cash-out refinance loan, you apply for a higher loan amount than you owe on your existing mortgage. This new loan replaces your original mortgage loan and you can receive the difference in cash.
Switch to a fixed-rate mortgage
If you have an adjustable-rate mortgage (ARM), your rate can change over time. Depending on the ARM, rates can change every month to every five years. As a result, a steep increase could affect your monthly payments and overall loan amount, making it difficult to budget and afford your payments.
By refinancing your mortgage, you could switch your loan to a fixed-rate mortgage and have predictable interest rates and monthly payments for the duration of your loan.
Types of refinancing
As you evaluate your mortgage refinancing options, keep in mind that there are four main types of refinancing loans.
Traditional mortgage refinancing
When you refinance your home loan, you pay off the existing mortgage and create a new one with different rates and terms. With traditional mortgage refinancing, you can potentially qualify for a lower rate, shorten or extend your loan term, or convert your loan to a different type of interest rate.
Cash-out refinance loans are best for those who have owned their home for long enough to have established equity in the home. As described above, cash-out refinancing is when you refinance your loan for an amount that is greater than what you owe on your existing loan. You can then use the difference as a cash payment for expenses like home renovations or medical procedures.
When you take out a cash-in refinance loan, you replace your current mortgage with a new one for a smaller principal amount after making a lump sum payment. Having a lower loan-to-value ratio could qualify you for a lower interest rate. You’ll likely also lower your monthly payments and potentially reduce your overall loan cost.
Streamline refinancing loans have less stringent underwriting criteria, so borrowers can qualify even if they have less-than-perfect credit. If you’ve had trouble qualifying for other forms of refinancing, a streamline refinance loan could be a good option for you.
Streamline refinance loans are only available to borrowers with government-backed mortgages, such as a VA loan or FHA loan. If you have a conventional mortgage, you won’t be able to take advantage of streamline refinancing.
Streamline refinance loans also come with no closing costs. If you opt for a no-closing cost loan, the lender will typically charge a higher interest rate than if you paid the closing costs in cash.
How to refinance your mortgage
If you’ve decided to refinance your mortgage and are wondering how to get a loan, the process is very similar to applying for a mortgage. You can refinance your existing home loan in just five steps:
Decide what you want to accomplish
Your goals for refinancing your mortgage will affect what lenders, loans, and terms are best for you. For example:
- Free up cash for other goals. If you want to reduce your monthly payments so you can save more money for retirement or cover other expenses, you may want to use traditional refinancing to get a new loan term and lower your payments.
- Pay off your mortgage sooner. To save the most money and pay off your mortgage faster, you can refinance your loans to get a better interest rate. You can also use a cash-in refinance loan and make a lump sum payment to lower your debt more quickly.
- Cash to update your home. If you want to renovate your bathroom or install a pool, you can use a cash-out refinance loan to pay off your existing mortgage with a larger loan and use the difference in cash however you want.
Research your options
There are many mortgage refinance companies out there, each with its own benefits and drawbacks. Before choosing a lender, it’s wise to request rate quotes from multiple mortgage lenders. Compare interest rates, loan terms, closing costs, and other fees to decide which lender will give you the best deal.
Mortgage companies will usually perform a hard credit inquiry before giving you a quote, which can affect your credit score. You can reduce the impact on your credit by requesting quotes from multiple companies within a limited window of time. FICO credit scores treat multiple inquiries for mortgages and mortgage refinance loans that occur within 30 days as a single inquiry rather than many.
Fill out an application
Once you’ve found a lender and loan that matches your needs, you can complete the application for refinancing. After filling out the application, the lender will ask for your consent to perform a hard credit check. Typically, the lender will require the following:
- W-2 forms for the past two years
- Pay stubs
- Bank statements for all bank and investment accounts from the last two months
- Copy of homeowners insurance policy
- For self-employed individuals, two years of business tax returns and your year-to-date profit/loss statement
- Most recent statement for your mortgage
Prepare for closing costs
Just like your existing mortgage, closing costs are a part of most mortgage refinance loans. Your total costs are dependent on the loan amount, but expect to pay 2% to 5% of the loan amount. On average, closing costs on refinance loans are approximately $5,000, so make sure you have money set aside or make arrangements with the lender to include the closing costs in the loan.
Close the loan
Once your application is approved, the lender will schedule an appraisal, verify your documentation, and set a closing date. Depending on the lender and the loan, it can take weeks before your loan will close.
A few days before your closing date, you’ll receive the closing disclosure that outlines the terms of the loan. Review it carefully to make sure it matches what you agreed to when you accepted the loan.
To close the loan, you’ll likely have to meet a closing agent at a title company. You’ll need to bring a state-issued photo ID (such as a driver’s license) and a cashier’s check or wire transfer to pay for closing costs or other fees. You’ll then review and sign the final loan documents and have a new mortgage loan.
Although the lowest mortgage interest rates are likely behind us, there still may be time to refinance your mortgage and enjoy the benefits. Refinancing now can make sense if:
- You had poor credit when you took out your mortgage and have improved it since then.
- You have an older mortgage with a higher interest rate.
- You have an ARM and are worried about interest rate fluctuations.
- You want to take advantage of your home’s higher equity and cover home renovations.
By contrast, mortgage refinancing likely isn’t a good idea if you took out your mortgage in the past three years since you likely have a lower interest rate than you can get now.
Before refinancing your mortgage, be sure to compare offers and consider your goals for refinancing. If you decide it’s time to refinance your loans, check out our review of the best mortgage lenders.
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