Refinancing your home mortgage may help reduce your interest rate, lower your monthly payments, move to a more stable loan product, or consolidate high-interest debt. One of the first mortgage refinance tips to follow is to familiarize yourself with how a refi works so you know what to expect.
Here’s some smart refinancing advice to help put you on the path to achieving your financial goals.
- 1. Boost your credit score and clean up your credit history
- 2. Maximize your home equity
- 3. Lower your debt-to-income (DTI) ratio
- 4. Choose the right mortgage for your financial goals
- 5. Calculate the break-even point and refi costs
- 6. Do the math on a no-closing-cost refinance vs. paying closing costs upfront
- 7. Respond quickly to your lender’s requests for documentation
- Refinancing FAQs
1. Boost your credit score and clean up your credit history
Your credit score will play an important role in not only your mortgage refinance application process, but also the rates and loan terms that you’re offered. That’s why it’s critical to boost your credit score and clean up your credit history prior to a refinance. Visit AnnualCreditReport.com to request a copy of credit report from each of the three credit reporting bureaus. You can pull your credit reports for free once each year. (Note: This is the only federally-approved website to pull your credit reports.)
Getting your full credit history allows you to catch and fix errors, and determine where you need improvement. Just be sure to leave yourself plenty of time to clean up your credit history before applying for a mortgage refinance, because it can take time for those efforts to boost your credit score.
2. Maximize your home equity
Your maximum mortgage refinance amount will be determined, in large part, by your home’s equity. That’s the difference between your home’s current value and the outstanding balance of your mortgage. The more home equity you have, the greater your allowable loan amount.
Home equity is especially important if you’re considering certain types of mortgage refinances, such as a cash-out refinance. A cash-out allows you to tap your home equity by replacing your current loan with a new one for a larger amount and withdrawing the difference in cash to use however you see fit.
As you pay down your loan balance, your home equity grows. Aside from making additional principal loan payments, here are a few other ways you can build equity faster:
- Make some low-cost home renovations and/or repairs that can increase the value of your home. Some ideas include fresh paint, new carpet, new kitchen appliances, new light fixtures and faucets, and updated knobs/pulls on all cabinets/drawers.
- Document any renovations or system upgrades (new roof or appliances, for example) that have been made since the home was purchased to boost its appraisal value.
- Enhance your home’s curb appeal by cleaning up and mowing the yard, adding potted plants and colorful flowers, and painting the home’s exterior.
Many lenders will require a home appraisal during the refinance process to assess your home’s current market value. Some borrowers may even qualify for an appraisal waiver on certain conventional loans, allowing them to skip the appraisal process altogether.
3. Lower your debt-to-income (DTI) ratio
In many cases, your debt-to-income (DTI) ratio affects your mortgage refinance approval and can impact your interest rate and loan approval. This calculation measures how much of your gross monthly income goes toward paying your monthly debt obligations, including your potential new mortgage payment.
There are two types of DTI ratios: front-end and back-end DTI ratios. The front-end ratio looks solely at how much of your gross monthly income goes toward your housing-related expenses. Meanwhile, the back-end, or total DTI ratio, evaluates how much of your income goes toward all of your revolving monthly debts (including your new mortgage payment). DTI ratio plays a role in your overall loan amount, borrowing costs, and your likelihood of a refi approval.
Each lender has its own borrower qualification requirements, including DTI thresholds. In general, you should aim to keep your total DTI ratio under 36%, if possible. Keep in mind that many lenders accept higher DTI ratios, typically with mitigating factors, such as higher credit scores and cash reserves.
To improve your DTI before applying for a mortgage refinance, you can:
- Increase your income, either by asking for a raise at work, applying for a promotion, changing jobs, or taking on a side hustle.
- Pay down existing debt, such as credit card balances, student loans, and auto loans.
- Refinance or consolidate high-interest debt to lower your monthly payment amounts.
4. Choose the right mortgage for your financial goals
The next step in the refinancing process involves determining which mortgage is the right one for you.
Here are common reasons why homeowners decide to refinance their mortgage:
- To get a lower interest rate
- To shorten their loan term to pay off their home more quickly
- To eliminate mortgage insurance payments
- To switch from an adjustable-rate mortgage to a fixed-rate loan
- To tap cash for home improvements, consolidating high-interest debt, buying a second home, and other financial goals
- To add or remove a borrower to a loan
Pinpointing your primary financial goal(s) is one of the top pieces of mortgage refinance advice. After you set a goal, then can you determine which loan programs and terms are ideal for your situation. There are two main refinance options:
- A rate-and-term refinance is your “typical” refi option. It allows borrowers to change their loan term, interest rate, monthly payment amount, or a combination of all three.
- A cash-out refinance allows you to tap your home’s equity by replacing your current loan with a new, larger mortgage, and gives you the difference in cash to use how you see fit.
5. Calculate the break-even point and refi costs
One of the most-overlooked refinance tips is determining the break-even point of your new mortgage. Calculating the breakeven, or the point at which you’ll recoup the closing costs and realize savings from the refinance, can help you decide whether a refinance is right for your situation. Ideally, you want to stay in your home long enough after a refinance to reach the break-even point, otherwise, you might lose money.
While a refinance should generally save you money in the long run, it will cost you money upfront in the form of closing costs. Closing costs typically range from 3% to 6% of the loan amount, depending on loan size and program.
Research and calculate all of the costs involved with the refinance process and your new mortgage loan. If you’re not lowering your interest rate and/or payments enough to realize long-term savings, or if you plan to sell your home in the near future, refinancing may not make sense for your situation.
6. Do the math on a no-closing-cost refinance vs. paying closing costs upfront
Some lenders may offer the option of a no-closing-cost refinance. However, there’s nothing “free” about it. Instead, you’re exchanging up-front closing costs for a higher principal balance (by rolling your closing costs into the loan), or a higher interest rate. Both avenues wind up costing you more in the long term on interest payments.
For example, say you’re applying for a $300,000 refinance and your lender offers you a rate of 3.2% for 30 years, which will cost you a total of $167,064 in interest over the course of the loan. Your closing costs in this scenario are 4% of your loan amount, or $12,000. If you opt to roll the fees into your loan amount, increasing it to $312,000), your refinanced loan will cost you about $173,746 in total interest payments.
Your other no-closing-cost refi option is to take a higher interest rate, say 3.7%, while your lender covers the up-front closing costs for you. While this may sound appealing, accepting a higher interest rate means you’ll now owe $197,105 in total interest charges over a 30-year term. That’s about $30,000 more in lifetime interest payments than a traditional refi loan had you covered closing costs upfront.
Before choosing a no-closing-cost refinance, ask your lender what it entails and do the math. If you plan to sell in a few years, this may keep more cash in your pocket. But if you plan to stay put for a while, you’ll pay more for the loan over the long run.
7. Respond quickly to your lender’s requests for documentation
Time is of the essence during a refinance approval. So when your lender asks you for documentation or needs clarification on your financial records, respond promptly. Dragging your feet may result in a longer closing timeline or potentially losing out on a locked interest rate if the rate-lock period expires.
According to the Ellie Mae Origination Insight Report from April 2021, the average time to close for all refinance loans was 53 days. If a buyer doesn’t respond to questions or documentation requests promptly, though, the process may be delayed and your refi could take longer to close.
Once you receive your refinance Loan Estimate and Closing Disclosure, review the documents carefully. Compare the loan terms, fees, and costs to ensure that including the repayment term, interest rate, and principal loan amount — and ask questions if something doesn’t match up or you don’t understand the contract.
Also, note your right of rescission. This rule allows borrowers to cancel their refinance loan for any reason within three business days of signing closing documents, without any financial penalty.
How long does the refinance closing process take?
The average mortgage refinance closing process takes 53 days, according to April data from Ellie Mae. This time frame can be shorter or longer, though, depending on the borrower’s situation, the lender’s unique process, responsiveness of both parties, and other factors.
When should you not refinance a mortgage?
It’s important to do the math to see how much you’ll save with a mortgage loan refinance, and when you’ll break even on your new loan. If your new interest rate isn’t significantly lower than your original rate, closing costs are too high, or you plan to sell in the near future, for example, refinancing might not be the right financial move.
Do you need a lawyer to refinance your home loan?
In some states, homeowners are required to hire a real estate lawyer to oversee a refinance closing. A real estate lawyer can analyze the contract, explain certain charges and agreements, and even help calculate the new loan’s total cost.
How much does a refinance cost?
Each lender sets its own refinance loan closing costs, which can include origination fees, application fees, mortgage points, title fees, and more. According to data from ClosingCorp, the national average refinance loan closing costs were $3,398 in 2020.