What is a mortgage refinance?
Refinancing your mortgage means getting a new home loan to replace an existing one. You typically follow the same steps you did for your purchase mortgage, except your new loan pays off your old loan.
A mortgage refinance can help you save money by:
- Reducing your interest rate. You aren’t stuck with your existing mortgage rate. A refinance can help you get the best mortgage rates available now.
- Shrinking your loan term. If you can pay off your mortgage faster, you’ll save big on interest charges.
- Putting cash in your pocket. A cash-out refinance can do all of the above and give you extra funds to put toward your financial goals.
But before you jump in, make sure you’ve set yourself up for a successful refinance by going in with a goal and a plan.
Should I refinance my mortgage?
A useful rule of thumb is that if a refinance can lower your interest rate by 1% or more, it likely makes good financial sense. However, the best way to determine for sure whether a refinance is in your best interest is to calculate your break-even point. To do this, just divide your total closing costs by your estimated monthly savings. The result is the number of months it will take you to benefit from the refinance savings.
For example, if a refinance saves you $150 on your monthly payment but costs you $5,000 in fees, the break-even point would be about 33 months, or just under three years ($5,000/$150 = 33.33). As long as you plan to stay in your home for at least three years, the refinance saves you money.
The Consumer Financial Protection Bureau (CFPB) recommends that you only refinance if you can “break even” within two years. However, as long as you’re planning to live in your home beyond the break-even point, a refinance won’t be detrimental to your finances. The longer you retain the home after refinancing, the more savings you’ll see.
Is now a good time to refinance?
With interest rates expected to remain high and continue to rise throughout 2022, it may not be the best time to refinance if you’re looking for a lower rate. However, there are other financially sound reasons to refinance now, including:
- Getting rid of mortgage insurance because your home’s value has increased.
- You can get rid of private mortgage insurance (PMI) on a conventional loan if you have 20% equity but, even if you don’t, you may be able to reduce it.
- Lowering your monthly payment by replacing a 15-year mortgage with a longer-term, 30-year fixed-rate loan.
- Paying your loan off faster by refinancing a 30-year term to a 10-, 15- or 20-year term.
- Paying off an adjustable-rate mortgage (ARM) before the ARM rate and payment adjusts higher than current 30-year rates.
- Tapping your home equity to make home improvements, consolidate debt or buy a vacation home.
- Replacing a government-backed loan with a conventional loan, to get rid of lifetime FHA mortgage insurance required on loans backed by the Federal Housing Administration (FHA).
How to refinance a home loan
Wondering how the mortgage refinance process works? It’s easy to get overwhelmed by all of the details involved, but follow these six steps and you’ll be well on your way:
Figure out your refinancing “why.” Do you want a lower mortgage rate? Can you afford a higher monthly payment and, in return, get a shorter loan term? Are you ready to borrow from your home equity?
- Gauge your financial health. Pull your credit reports and scores. A credit score of at least 740 will typically get you the best rate offers. Budget enough cash reserves to cover your refinance closing costs, which can range from 2% to 6% of your loan amount.
- Gather information about your home’s value. Try a home value estimator or contact your real estate agent to help pinpoint your home’s value. The more equity you have, the lower your rate will typically be.
- Shop around and apply. Pick three to five refinance lenders and fill out applications with each. FICO, the company behind the credit scores most used in lending, recommends that you complete those apps within a 14-day time frame to minimize the temporary hit to your credit score from multiple hard inquiries.
- Lock in your mortgage rate. Once you’ve committed to a lender, get a mortgage rate lock to secure the interest rate you were quoted.
- Close on your refinance. Work with your lender to finalize your refinance, submit any outstanding paperwork and schedule your closing date.
Types of refinance loans
The most common types of mortgage refinance options are offered by conventional lenders, as well as lenders approved by the Federal Housing Administration (FHA), U.S. Department of Veterans Affairs (VA) and U.S. Department of Agriculture (USDA).
- Rate-and-term refinance loans. This is the most traditional type of refinance and often serves the purpose of changing your mortgage rate and/or repayment term.
- Cash-out refinance loans. With a cash-out refinance, you get a new mortgage that has a higher balance than what you currently owe on your existing loan. You pocket the difference between the two loans in cash.
- Streamline refinance loans. The streamline refinance option is exclusive to homeowners with government-backed loans from the FHA, VA or USDA. In most cases, no home appraisal or income documentation is required. To qualify, you just need to currently have an FHA, VA or USDA loan and be able to show that the refinance will benefit you financially.
- High loan-to-value (LTV) refinance loans. Homeowners with conventional loans who have little to no equity may qualify for a high-LTV refinance. The maximum LTV ratio allowed when refinancing a conventional loan is 97% for a rate-and-term refinance or 80% for a cash-out refinance.
Common minimum refinance requirements
The table below gives you a quick glance at the refinance requirements for credit score, debt-to-income (DTI) ratio and LTV ratio for the types of refinance loans above:
| Loan program | Refinance purpose | Credit score | LTV ratio | DTI ratio |
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| Conventional |
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| FHA |
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| VA |
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| USDA |
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