When to Refinance Your Mortgage: Finding the Right Time
Figuring out when to refinance a mortgage can be tricky, but the key is this: You should do it when you know you’ll receive a financial benefit.
A mortgage refinance provides you with a new mortgage that pays off and replaces your old one. Refinancing can help you by lowering your monthly mortgage payment, improving your overall loan terms or allowing you to tap your home equity. Here’s how to know when the time is right.
How does refinancing work?
Taking out a refinance loan is a great opportunity to change any loan terms that weren’t ideal in your original loan. For instance, you can refinance into a lower interest rate or shorter loan term.
Just keep in mind that in order to take advantage of these perks, you’ll have to pay refinance closing costs. This means that you’ll need to compare the financial benefits of refinancing to the costs to make sure that it’s going to be worth it.
If you’re wondering how to refinance a house, rest assured that it’s very similar to the process you went through when you took out your purchase loan.
- Do your research Pick a few lenders and loan programs that will help you meet your refi goals.
- Apply with several lenders Compare offers to find the best one.
- Lock in your rate A mortgage rate lock will help you keep the rate you were offered, even if rates rise as you head toward closing.
- Get an appraisal A home appraisal will demonstrate that your home has enough value to justify your refinance loan amount.
- Pay your closing costs Expect to pay around 2% to 6% of your total loan amount.
- Close on the loan Your new lender will pay off your old lender, leaving you with only the refinance loan to worry about.
When to refinance a mortgage
It takes time and money to refinance a home loan, which is why it’s important to understand how you’ll benefit from the process. Here’s when to refinance a mortgage:
When you can get a lower interest rate
Let’s say you took out a 30-year fixed-rate mortgage five years ago. You started with a $200,000 loan, a 4.5% interest rate and a $1,013 monthly mortgage payment (principal and interest). You recently checked refinance rates and noticed you could get a new 30-year loan at a 3.25% rate, lowering your monthly payment by more than $140.
When you want to shorten your loan term
If you can pay off your mortgage much sooner due to an increase in your income, it might make sense to refinance into a shorter-term mortgage. The caveat: While you can secure a lower mortgage rate with a shorter loan term, you’ll have a higher monthly payment since there’s a shorter amortization schedule. Be sure your budget can handle the higher payments.
When your credit score has gone up or your DTI ratio has gone down
Two major factors that affect mortgage rates are your credit score and debt-to-income (DTI) ratio. If you’d like to refinance into a mortgage with better terms, you may need to be better off financially than when you borrowed your existing loan. The best interest rates are typically reserved for those with at least a 780 credit score. On the other hand, the lower your DTI ratio — the percentage of your gross monthly income used to pay all your monthly debts — the less risky you are to lenders. Try to keep your ratio below 40%; it could save you money at closing if you’re using a conventional loan and borrowing more than 60% of your home’s value.
When you need to switch your loan type
Whether you have an adjustable-rate mortgage (ARM) and want the stability of a fixed-rate loan, or you would like to switch from an FHA loan to a conventional loan, you’ll need to refinance to make the change.
Why switch your loan type?
- To get out of an ARM before its rate adjusts Interest rates on ARMs can rise by quite a bit when they adjust, which can make or break a loan’s affordability. Ideally, you wouldn’t have taken out an ARM if you couldn’t afford to make payments at the maximum amount allowed by the terms of the loan — but that doesn’t mean you want to be stuck there. Getting out of an expensive ARM, or getting out before the rate adjusts, could save you a great deal in interest costs.
- To get rid of FHA mortgage insurance If you borrowed an FHA loan and put down less than 10%, you’ll pay mortgage insurance premiums for the life of the loan. Refinancing into a conventional loan allows you to get rid of that extra monthly cost. You’ll need 20% equity in your home, though, to refi into a conventional mortgage with no private mortgage insurance (PMI) — otherwise, you’ll have to pay for PMI on your new loan until you gain enough equity to get rid of it.
When you want to tap your home equity
Perhaps you need to fund your home improvements, cover college costs, consolidate debt or handle an unexpected emergency. A cash-out refinance can help with those goals, but you’ll usually need at least 20% equity to qualify. Here’s an example: Your home is worth $300,000 and you owe $100,000 on your existing mortgage, giving you $200,000 in equity.
Since you have to maintain a minimum amount of equity in your home after a cash-out refinance, you can’t borrow the full amount, which limits your maximum loan-to-value (LTV) ratio, or the percentage of your home’s value being financed by the mortgage. Multiply $300,000 by 80% to get $240,000, then subtract your $100,000 loan balance to get $140,000. This is the maximum amount of equity you can cash out of your home.
How soon can you refinance a mortgage?
The amount of time you’ll have to wait to refinance after closing on a home varies depending on the loan type, loan program and the type of refinance you’re seeking. To get cash out, you’ll have to wait between six and 12 months. For a simple rate-and-term refinance, you can refinance at any time if it’s a conventional loan, after seven months if it’s an FHA streamline refinance, after 210 days (or six payments, whichever is longer) if it’s a VA loan or after 12 months if it’s a USDA loan.
When should you wait to refinance your home loan?
Refinancing your home doesn’t always make financial sense, especially if you plan to move within a few years or have damaged credit. Here are some scenarios when refinancing your mortgage isn’t a good idea:
- You’re selling your home soon. One of the most important calculations in a refinance is your break-even point. If you won’t stay in your home long enough to recoup your refinance closing costs, you could end up losing money.
- You’re close to paying off your existing loan. If you’re in the home stretch of a mortgage payoff, starting the clock over with a new, long-term loan means you’ll pay significantly more in interest charges. Consider sticking it out or choosing a shorter repayment term to achieve your refi goals.
- Your credit score is struggling. A not-so-great credit score can bump up the refinance rate you’re quoted and cost you more money in the long run.
- You need to focus on other financial goals. If the money you’ve set aside to refinance your mortgage could be used to pay down high-interest debt or beef up your emergency fund, consider prioritizing those goals first.
- You could face a prepayment penalty. Some lenders charge you a hefty fee — known as a prepayment penalty — if you pay off your loan in the first few years of borrowing it. Your new loan pays off your old mortgage when you refinance, so if that would trigger a penalty, you’ll pay more than expected for your refi. You can find out whether your existing loan terms include a prepayment penalty by checking your closing disclosure.
- You just want access to cash, and you haven’t evaluated whether a cash-out refinance, home equity loan or home equity line of credit (HELOC) would suit your needs best. Make sure you take the time to fully understand and consider refinance alternatives before you jump into a new home loan.
5 things to consider before a mortgage refi
If you want to refinance your mortgage, review the following considerations before starting the refi process:
→ How many years are left on your existing loan?
If you have 20 years left on your current mortgage and decide to refinance into another 30-year loan, you’re restarting your amortization schedule and significantly increasing the interest you’ll pay over the life of the loan. Try refinancing to a shorter term if your budget can handle it.
→ How long do you plan to stay in your home?
If you’re selling your home in a few years, refinancing may not benefit you as much as you think. Calculate your break-even point to determine how much time it’ll take you to recoup your closing costs.
→ What’s the current interest rate environment?
Mortgage rates are unpredictable, but if they’ve dropped enough to give you the savings you’re looking for in a refinance, you might want to act quickly.
→ Is there room for improvement in your credit score or DTI ratio?
Pull your credit reports from Equifax, Experian and TransUnion for free at AnnualCreditReport.com and get a free credit score online. If you have time to improve your score or pay off debt to boost your chances of a refinance approval or lower closing costs, it might make sense to wait.
→ How much does it cost to refinance?
You’ll need to set aside funds to cover your refi closing costs, which, again, can range anywhere from 2% to 6% of your loan amount. You may be able to roll those costs into your loan, but a larger principal amount means you’ll have higher monthly payments and increased interest costs in the long term.
Is refinancing worth it?
There are several factors to consider before you decide whether refinancing makes sense for your financial situation and your goals.
If you bought your home or last refinanced during a higher-interest-rate environment, or if you fit into one or more of the scenarios mentioned above, now could be a good time to consider refinancing your home. A mortgage refinance calculator can help you crunch the numbers on how much the refinance will cost versus how much it will save you in the long run.
Is now a good time to refinance?
Interest rates are currently back down below 7% — a threshold they broke in October 2022 for the first time in nearly 20 years — but they aren’t exactly low. As a result, only 17% of mortgages taken out between August 2022 and January 2023 were refinances. Homeowners refinancing in order to get a lower interest rate simply don’t have as much to gain from refinancing right now as they have in recent years.
However, there are other reasons to refinance and other ways to lower your interest rate, so it could still make sense to refinance now. For instance, if you want to get out of an ARM or FHA loan and into a different loan type, or if your credit or DTI ratio has improved significantly since you financed your home, then refinancing could make sense.
But if you’re just waiting for interest rates to fall, you may want to put your refinance plans on hold and keep an eye on the mortgage rate forecast so you’ll be ready to refinance once the market is in a more beneficial place.
Cash-out refinance rate changes for 2023
As of May 1, 2023, you could pay extra fees at closing on conventional cash-out refinances. The amount will range from 0.125% to 5.125%, depending on your credit score, LTV ratio, DTI ratio and the type of property you’re refinancing.
Frequently asked questions
Interest rates for a refinance are often slightly higher than for a purchase loan. As of early 2023, refinances rates are on average 21 basis points more expensive than purchase rates.
There is no specific law that prevents you from refinancing your home as many times as you’d like. However, you’ll have to meet your lender’s refinance requirements each time you take out a new loan. These requirements include holding a minimum amount of equity, and since each time you borrow against your equity you essentially “use up” some of that equity, you’re dealing with a finite resource — if you refinance repeatedly, at a certain point you won’t have enough equity to continue taking out refinance loans.
The overall benefit of refinancing is that you have an opportunity to get into a new home loan that better suits your financial needs. The specific benefits you’ll gain from refinancing will depend on the terms of your new loan, your financial situation and your financial goals.
Between August 2022 and January 2023, it took around 50 days for a refinance to close, according to <a href=”https://www.icemortgagetechnology.com/” rel=”noopener noreferrer nofollow” target=”_blank”>ICE Mortgage Technology</a>, a digital loan origination platform provider.