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How to Refinance Your Mortgage in 8 Steps

Photo illustration to accompany article on how to refinance your mortgage Shutterstock
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If you’re thinking about refinancing your mortgage, it may be wise to do it sooner rather than later.

Recent trends indicate that both global and national uncertainty is driving an interest rate surge after the historic interest lows of the past two years. One expert even told NextAdvisor that the average mortgage rate could hit 5% soon — so the time to compare lenders is now.

However, refinancing your home takes some finesse, especially in a climate of rising interest rates. During the economic downturn brought on by the pandemic, interest rates were at record lows. Refinancing was somewhat of a no-brainer, said Greg McBride, chief financial analyst at Bankrate.com, in a 2020 interview with us, explaining it wasn’t a bad idea to consider refinancing at that time.

But what about now? Refinancing “can really be onerous, and it may not save you that much money in the end,” says Jill Schlesinger, CBS news analyst and author of “The Dumb Things Smart People Do With Their Money.”

Yet, a well-planned refinance, or “refi,” can help you tap into your home’s equity, free up cash, or adjust your loan terms to one that better fits your current situation. 

So is refinancing your mortgage right for you? Here’s how to know — and the steps you need to take if you do decide to refinance. 

What Is a Mortgage Refinance?

A mortgage refinance is when you take out a home loan to replace your existing mortgage. The new mortgage can be taken out with your current mortgage lender or a different lender. Homeowners usually refinance to take advantage of better interest rates or more favorable terms.

How to Refinance a Mortgage

Refinancing is fairly simple — at least in theory. It means taking out a new loan to pay off your current mortgage, either with your current lender or a new one. Most homeowners refinance to take advantage of low mortgage rates, but sometimes it’s about changing the loan terms, getting rid of mortgage insurance, or freeing up the equity in a home to use for other purposes such as debt payoff or paying educational costs. 

Average mortgage refinance rates have risen sharply from the historic lows of 2020 and 2021, but you may still be able to get an advantageous rate by shopping around with multiple lenders. Some homeowners may also qualify for better interest rates than when they first took out their mortgage if their credit score has improved due to consistent payment history. However, qualification happens on a borrower-by-borrower basis and every lender has different requirements.

Here’s an overview of the mortgage refinancing process and the steps you should follow for a successful refi:

1. Set a financial goal

First, take a look at your finances and your budget. Consider what you’re hoping to accomplish with your mortgage refinance. 

There are four main reasons people refinance, according to Rick Robertson, a certified mortgage planning specialist with Axia Home Loans in Bellevue, Washington.

  1. To lower the interest rate on their mortgage, increasing monthly cash flow. “This can be very helpful and redirect a monthly cash flow into other areas that are more pressing at the current time,” says Robertson.
  2. To shorten the loan term, for example, from 30 to 20 years, which can save interest over the long term.
  3. To take cash out of the refinance and use the equity you have in your house to consolidate debt, pay for education, or make home improvements; this is called a cash-out refinance
  4. To change their loan from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage.

Think about what you’re hoping to gain from your refinance, and share that when you talk with bankers or mortgage brokers, so they can better understand what type of refinance might make the most sense for you. 

2. Determine how much equity you have in your home

Home equity is a crucial piece of the puzzle when deciding if it’s worth refinancing your home.

The amount of equity in your house is calculated as the difference between the current market value of your home and the remaining balance on your mortgage. 

For instance, if a house is worth $300,000 and the homeowner has paid $200,000 on their mortgage, that leaves them with a remaining mortgage of $100,000. In this scenario, the homeowner could choose to refinance and take out a new mortgage for the $100,000, thereby possibly qualifying for a lower interest rate and lower monthly payment.

Lenders usually use what’s called a loan-to-value ratio (LTV) calculation to determine whether a homeowner can refinance their mortgage and/or how much of their equity they can cash out. This calculation is also instrumental in determining whether homeowners can take out a home equity loan of some kind. 

LTV is calculated by dividing the amount borrowed by the property’s value. In the example above with a $300,000 house and $100,000 mortgage balance, the LTV would be 33%. 

3. Gather the necessary documentation

McBride’s top piece of advice for people wanting to refinance is simple: Come prepared. Collect your financial documents and have them ready for lenders. The documentation you will likely need for a refinance include:

  • Pay stubs or other proof of income
  • Bank statements
  • Tax documents, such as W-2s, tax returns, and 1099s
  • Proof of homeowners insurance coverage
  • Statement of debts, such as car loans, student loans, mortgage(s), any lines of credit
  • Documentation of assets (savings, stocks, bonds, 401(k), CDs, etc.)
  • Copy of title insurance

You should also check your credit score and credit report to get a sense of where you stand. You get a copy of your free credit report at AnnualCreditReport.com. Many banks or credit card companies will let you see your credit score for free in your account. 

4. Shop and compare rates 

You can shop and compare refinance rates online without stepping foot into a bank, or you can inquire in person at a local branch. Whether you use a new lender or a mortgage broker you’ve worked with before, choose one you trust. Shop around and compare offers from multiple lenders to ensure you’re getting the best deal. The Federal Reserve Board provides this handy mortgage refinance shopping checklist with 13 questions to ask each lender.  

It’s worth it to do the research, McBride advises, but beware of low advertised rates. Depending on your credit history, you may not qualify for what you see. In addition, sometimes advertised rates may have hidden terms attached or mortgage points factored into the calculation. 

Some consumers prefer using a mortgage broker. A mortgage broker acts as a liaison between lenders and clients. Most brokers work on commission — usually paid by the mortgage lender — and will shop for lenders and rates on your behalf.  

5. Apply with multiple lenders

According to the experts, you don’t need to limit yourself to one potential mortgage broker or lender when you’re submitting your applications. Consider talking with multiple mortgage lenders and brokers. Three is a good number of lenders to speak with and get loan estimates from, says McBride. 

This advice is especially important if your credit score is not quite as good as it could be. Each bank has its own criteria for determining who to lend to. If one bank turns you down because of your credit score, income, or debt-to-income ratio, another may not. You may also find the rates at one to be better, but the only way to know which lender is the best fit for your loan is by applying to more than one. 

Aim to evaluate different lenders within a short period of time. Once you initiate a credit inquiry for a mortgage refinance, you then have 14 to 45 days (depending on the scoring model that’s used) to have additional credit pulls from competitors without negatively impacting your score. Multiple mortgage loan credit checks will be counted as one check if performed in that window. 

Pro Tip

Never settle on your first offer. Shop around for the best refinance rate, broker, and lender.

6. Get a home appraisal 

Most mortgage lenders will require a professional appraisal of your home when considering your application. That’s not something to worry about, and you may find your house is worth more than you realized — a common occurrence in the current housing market. But on the other hand, you might also find your house is worth less than you expected. As long as the appraisal doesn’t find that your house is worth less than the new mortgage is for, it won’t impact your refinancing.

You may be able to get a no-appraisal refinance if you meet certain conditions, but that has its own pros, cons, and risks involved. 

7. Choose a lender and lock in your rate

Once you hear back from the lenders you applied to, you’ll be able to make your choice. If your lender approves your application, you should receive a loan estimate that details your loan amount, interest rate, closing costs, and other information. Use the information you find in the loan estimate to compare lenders.

Your decision will likely be influenced by who offers the lowest rate, but there may be other elements to take into consideration. Do you want a lower rate or a shorter term? Is good customer service a factor for you? Do you want to go with a local banker to support local businesses in the community? Do you like the financial security of a large, corporate bank? Think about what’s important to you, then lock in your rate with your chosen lender.  

8. Close on the refinance loan and pay closing costs 

The final step of the mortgage refinance process, the closing, involves finalizing the transaction and signing all the paperwork. One important document is the final closing disclosure, which details the closing costs.

By this time, there will have been an assessment of your home, and any necessary details — such as repairs contingent on the deal — will have been taken care of. The actual closing will include you, a bank or broker representative, and probably a lawyer. 

Refinancing often comes with closing costs that add up to 2% – 5% of the loan value. These closing costs include a variety of fees, including title fees, lender fees, appraisal fees, and more. If you’re paying closing costs upfront, you’ll need to bring a check with you. 

Another option is to get a “no-closing cost” refinance. Despite the name, “no-closing-cost” refinances don’t truly eliminate your closing costs; they simply change how you pay for them. You can choose to either roll your closing costs into your loan balance or accept a higher interest rate in exchange for a lender credit to cover your closing costs. 

If you’re doing a cash-out refinance, you will have to wait three days to receive your money due to the right of rescission, which gives you three days to cancel your refinance if you change your mind.

When to Refinance Your Mortgage

There are a number of reasons why you would want to refinance your mortgage, but they all boil down to one thing–are you improving your current situation? Common motivations to refinance include: 

Reducing your monthly payment

One of the most popular reasons for refinancing your mortgage is to reduce your monthly payment by lowering your interest rate. Many homeowners took advantage of historically low interest rates in 2020 and 2021 to refinance. Mortgage rates have risen sharply since then and are projected to continue to rise, making refinancing less advantageous in the current rate environment.

Despite higher market interest rates, refinancing can still be viable for some homeowners. If you didn’t refinance during the pandemic and your current interest rate is higher than the market rate, it’s still worth checking your rate and crunching the numbers to see how much you can save.

And, since the interest rate you get depends on your individual credit and financial profile, if your credit score has increased significantly since you first took out your mortgage, you could get a lower interest rate than what you currently have even if average mortgage rates have increased.

Getting rid of private mortgage insurance

Another common reason for refinancing is to get rid of mortgage insurance. Private mortgage insurance (PMI) on conventional loans and FHA mortgage insurance on FHA loans protect the lender in case the borrower defaults on the mortgage. PMI is usually required when you put less than 20% down on the house, while FHA mortgage insurance is required for all FHA loans. The insurance premium is included in your monthly payment and presents an additional cost for homeowners.

With conventional loans, you can contact your lender to get rid of PMI once you reach 20% equity in your home. However, if your home’s value has increased dramatically since you took out your mortgage, you may be able to get rid of PMI earlier by refinancing — which requires a new appraisal. Even if your remaining loan balance is the same, the amount of equity you have will increase because your home is now worth more.

Unlike with a conventional loan, you can’t automatically get rid of mortgage insurance on an FHA loan once you reach 20% equity. Instead, you’ll need to refinance to a conventional loan.

Even if you can’t get a lower interest rate with a refinance, the monthly savings from getting rid of mortgage insurance could still make it worth it. At the end of the day, crunch the numbers to see if it’s right for your individual situation.

Refinance vs. Cash-Out Refinance 

A cash-out refinance works just like a normal mortgage refinance except you take out a loan for more than what you owe on your existing mortgage. Then you can use the extra money for things like home improvements or paying off other high-interest credit card debt.

Most lenders will limit cash-out refinances to an 80% loan-to-value ratio, meaning you must keep at least 20% equity in your home. For example, if you had a $100,000 remaining mortgage balance on a house worth $300,000, you would be able to take out a refinance worth up to $240,000. After paying off your original $100,000 mortgage with that money, you’d be able to keep $140,000 in cash while maintaining $60,000 (20%) equity in your home.

Cash-out refinancing, like regular refinancing, comes with closing costs that typically amount to 2% to 5% of the loan balance. Because of this, while you may get a lower interest rate compared to other forms of borrowing, cash-out refinancing can require more of an upfront investment.

Cash-out refinancing experienced a boom during the historically-low rate environment of the pandemic, but rising rates have made cash-out refinancing less attractive for many borrowers. If you recently refinanced and you don’t want to give up your low current interest rate just to tap into your home equity, a home equity loan or home equity line of credit (HELOC) might be a better option for you. 

Home equity loans and HELOCs, commonly referred to as second mortgages, let you borrow against your home equity without altering your primary mortgage. Their relatively low interest rates and large loan amounts make them ideal for large expenses like home improvements or consolidating debt. You can compare current home equity loan rates and HELOC rates to find the best form of financing for your needs.

Pros and Cons of Refinancing Your Mortgage

Pros

  • Allows you to eliminate PMI and FHA mortgage insurance

  • Could lower your interest rate

  • Could reduce your monthly mortgage payment (by lowering your interest rate or lengthening your loan term)

  • Lets you turn your home equity into cash through a cash-out refinance

Cons

  • Comes with closing costs

  • Market refinance rates are not as advantageous as they were a year ago

  • Substantial amount of paperwork and time involved

  • You might not qualify for favorable rates if your credit is poor

  • Must stay in your home long enough to break even on the upfront costs

Best Mortgage Refinance Lenders 

If you’re ready to refinance your mortgage, here are NextAdvisor’s top picks for the best mortgage refinance lenders to work with in 2022:

  1. Guaranteed Rate: Best With Fast Preapprovals and Closings
  2. Navy Federal Credit Union: Best for Military Families
  3. Rocket Mortgage: Top Lender for Customer Satisfaction
  4. Veterans United Home Loans: Top Lender Among Military Families
  5. North American Savings Bank: Best for the Non-Traditional Borrower
  6. Truist Bank: Best for Full Service Banking
  7. Sebonic Financial: Best Online Application Process
  8. Pennymac Loan Services: Best Online Experience
  9. Watermark Home Loans: Best for the Self-Employed Borrower
  10. LenderFi: Best Pricing Transparency

You can learn more about these lenders and why we chose them here

The Bottom Line

The refinance process is not easy, says Schlesinger. All the more reason, she says, to do your homework: research your options, create a realistic budget, and be honest with what you’re trying to achieve through a refinance. 

Frequently Asked Questions (FAQ)

How soon after closing on a house can I refinance?

There’s no formal waiting period for most conventional mortgages, but some government-backed mortgages require a waiting period of at least six months. For a cash-out refinance, your lender will likely require a long enough waiting period to make sure you have sufficient equity in the house.

Just because you can technically refinance your mortgage as soon as rates dip, doesn’t mean you will always qualify for a better rate or that you want to submit applications every few months. The right answer for you depends on your credit history and how long you’ve been making payments on the house. You also don’t want to raise too many flags with the credit bureaus by conducting a credit inquiry more than you need to. And remember — it often takes about five years to reach the break-even point on the upfront costs you paid, so you should be thoughtful each time you decide to refinance.

Are there alternatives to refinancing?

If you are refinancing to pay your mortgage off quicker, you could call your lender to see if you can adjust your monthly payment. Paying slightly more on your mortgage than you owe each month will help you pay it off faster. You could also consider making a large, one-time payment toward your mortgage in a process known as mortgage recasting.

If your goal is to get cash to finance a large purchase or project, you can try taking out a home equity loan or a home equity line of credit (HELOC) instead of a cash-out refinance. Other alternatives also include personal loans or 0% APR credit cards.

Finally, if you’re trying to reduce your monthly payment because you can no longer afford it, reach out to your lender directly to see if they can offer forbearance, a loan modification, or any other forms of assistance to lower your monthly cost.

Does refinancing hurt your credit score?

Because refinancing involves a hard credit inquiry, it will affect your credit score. Excessive credit inquiries can ding your score by a few points, which is why you don’t want to refinance every six months. However, the potential upside of refinancing can save you thousands over time and even improve your score. For example, if you do a cash-out refinance and use the money to pay off debt, you will likely see a fast improvement in your score.

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