How to refinance your mortgage

Amy Fontinelle

By Amy Fontinelle
Amy Fontinelle is a personal finance writer focusing on budgeting, credit cards, mortgages, real estate, investing, and other topics.
Posted on Jun 2, 2020

Refinancing your mortgage can be a great way to make progress on your financial goals. Housing is a major monthly expense, and refinancing lets you cut that cost without the upheaval of moving or getting a renter.

Also, since you already know what it’s like to get a mortgage, refinancing can feel pretty simple. Still, it’s important to be clear on what you hope to gain from the process and how refinancing works to make sure you’ll come out ahead.

You might want to refinance because…

  • Interest rates have gone down since you took out your mortgage.
  • Your budget needs trimming.
  • You want to pay less interest over the long run.
  • You want to pay off your home faster.
  • Equity is enough that you can get some needed cash.
  • You want to get rid of private mortgage insurance (PMI).

“A little effort can often save you thousands of dollars in interest and fees over the course of your loan,” said R.J. Weiss, a Certified Financial Planner™ and founder of the personal finance site The Ways to Wealth.

Here’s a look at the most common motivations for refinancing, what you need when shopping for a loan, and how refinancing works.

Motivation 1: Interest rates have gone down.

Should you refinance when rates go down? Getting a lower interest rate on a loan is generally a good thing, but restarting the clock on your mortgage might cost you in the long run. Here’s an example that shows why.

Amount to refinance: $200,000

Current interest rate: 4.0 percent

Years remaining on mortgage: 25

Total interest remaining before your home is paid off: $116,702

New interest rate: 3.5 percent

Years on new mortgage: 30

Total interest remaining before your home is paid off: $123,312

To make lower interest rates work in your favor, you must be clear on what you’re trying to accomplish.

Motivation 2: You need to trim your budget.

In the example above, you will pay more interest in the long run despite refinancing into a lower rate because you’re adding five years to your repayment period. But spreading out the $200,000 you owe (plus interest) over 30 years at 3.5 percent instead of 25 years at 4.0 percent means a monthly payment of $900 instead of $1,000. You might be okay with paying more interest over the long run because you’d rather have $100 extra per month in the short run.

Refinancing also lets you “skip” one mortgage payment. Since the interest you currently owe gets included in the amount you refinance and your first new payment won’t be due right away, refinancing can improve your current cash flow and provide relief if money is tight. But, you’re still paying interest for every day you borrow money — what you’re doing is more like postponing a payment.

Motivation 3: You want to pay less interest in the long run or be mortgage-free sooner.

One way to pay less interest over the long run is to make extra mortgage payments. You might pay your mortgage every two weeks instead of once a month, pay additional principal with each monthly payment, or make one extra payment per year when you get a tax refund or a work bonus.

The benefit of this strategy is that you don’t have to refinance. That means no shopping around, no paperwork, and no fees. Let’s go back to our example of the $200,000 mortgage at 4.0 percent with 25 years and $116,702 in remaining interest payments. Making one extra monthly payment per year would get your mortgage paid off in 22 years and 11 months and shave your total interest to $99,856 — a savings of $16,846, as long as you can throw an extra $955 at your mortgage principal every year.

Another way to pay less interest is to refinance at a lower rate — let’s say 3.5 percent — into a 25-year, 20-year, or 15-year mortgage. Would the extra savings be worth it?

Years remaining on new mortgage: 25

Total interest before your home is paid off: $100,374.14

Worth it? Maybe not. You could just make one extra payment per year instead.

Years remaining on new mortgage: 20

Total interest before your home is paid off: $78,380.66

Worth it? Perhaps, if you can afford the higher monthly payment.

Years remaining on new mortgage: 15

Total interest before your home is paid off: $57,357.71

Worth it? Again perhaps, if you can afford the higher monthly payment.

The combination of a lower rate and a shorter term could potentially save a lot over the long run. And saving money on interest over the long run goes hand in hand with another goal you might have: paying off your home faster.

Motivation 4: You need cash and you have equity.

Prime borrowers with conventional mortgages cashed out an estimated $90.9 billion in home equity when they refinanced in 2019, according to Freddie Mac. When you do a cash-out refinance, you’re borrowing more than your current loan balance to get money for improving your home, starting a business, paying off debt, funding an education, or any other purpose.

Similar to a home equity loan or line of credit, how much you can borrow depends on how much your home is worth. If you owe $200,000 on a home currently valued at $300,000, your equity is about 33.3 percent. Your lender will usually want you to retain at least 20 percent equity after cashing out. This guideline means you can borrow an additional 13.3 percent of $300,000, or about $40,000. Your new mortgage will be for $240,000 or less: you don’t have to cash out the full $40,000 if you don’t want to.

Since you’re borrowing more than you currently owe, your interest rate might be higher than if you were borrowing the same amount. Your monthly payment could also increase, and your total interest over the life of the loan may be higher. These factors are all interrelated and depend on the rate you get and the loan term you choose. Closing costs when you cash out typically total 3 percent to 5 percent of the amount borrowed.

Some homeowners do the opposite: a cash-in refinance. They take a chunk of their savings and put it into paying off their mortgage. A common reason to do this is to get rid of private mortgage insurance. You may be able to eliminate PMI without cashing in if your home’s value has gone up enough to give you at least 20 percent equity.

How much does it cost to refinance?

The interest rate to refinance is typically about the same as the rate to purchase, according to one survey of mortgage lenders. Closing costs are also similar, ranging from 2 percent to 6 percent of the loan amount, or $2,000 to $6,000 of every $100,000 you borrow.

The cost to refinance should be factored into your decision. You’ll want to calculate the break-even period if you’re trying to save money by refinancing. How long will it take before your interest-rate savings surpass your closing costs? Do you plan to keep your new mortgage longer than that?

Keep in mind that if you roll your closing costs into your loan — an attractive option if cash is tight — you could be paying interest on those costs for the next 15 to 30 years.

However, if you’re planning to move within five years, it can make sense to roll your closing costs into the loan, Weiss said.

Shop for the lowest APR

You may want to refinance with the same company that already services your mortgage. But before you go that route, compare offers from several lenders. There are nearly 12,000 out there.

“I recommend shopping with both a mortgage broker and an online bank, including going direct with the larger banks and using comparison tools,” Weiss said. “What you're then looking for is comparing total costs over time, including fees and interest on your loan.”

A loan’s annual percentage rate (APR) will show you those total costs. If you only look at the interest rate, you’re not getting the full picture.

A mortgage broker’s services are free. They connect borrowers with lenders and can help you find a better deal than you might find on your own.

Submit the loan paperwork

The loan paperwork to refinance is similar to the loan paperwork to purchase. Your lender will need to verify your income and assets to make sure you can repay the new loan. The sooner you provide the documents your lender requests, such as pay stubs and bank statements, the sooner you can close. The lender may also require a home appraisal depending on how much equity you have and the type of loan you’re applying for.

At some point, you will need to lock your interest rate. It can feel like a gamble, because while a rate lock protects you against rising rates, it also boxes you in if rates drop. (Related: How falling interest rates may impact you)

A good strategy is to lock on a rate you’re comfortable with, then stop thinking about it. The lock period needs to be long enough that it won’t expire before your loan can close. In the event of a major interest rate drop, you may be able to pay the lender a fee for a “float down” to a lower rate, or cancel your application and restart the process with a different lender.

Close the loan

Closing your refinance loan usually means having a notary verify your identity and witness your signing of all the loan documents. In states that allow it, borrowers can use a remote online notarization service through videoconferencing rather than meeting with a notary at a loan office or having a mobile notary come to their home.

Look out for yourself

Remember: Before deciding to refinance, run the numbers for your own situation to see if refinancing makes sense. Ask your financial professional for help if you’re unsure. Then, it’s smart to apply with several lenders to find a competitive rate. If everything works out, refinancing your home loan can be a way to lower your monthly payment, pay less interest, or free up some cash.

Learn more from MassMutual…

Saving money — and staying safe — when shopping for a loan

Is it OK to retire with a mortgage?

Setting financial goals: Debt

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The information provided is not written or intended as specific tax or legal advice. MassMutual and its subsidiaries, employees, and representatives are not authorized to give tax or legal advice. You are encouraged to seek advice from your own tax or legal counsel. Opinions expressed by those interviewed are their own and do not necessarily represent the views of MassMutual.