How to Determine If Refinancing Your Mortgage Is Right For You
Joy Wallet is advertiser-supported: we may earn compensation from the products and offers mentioned in this article. However, any expressed opinions are our own and aren't influenced by compensation. To read our full disclosure, click here.
One of the biggest advantages of owning a home is that each of your monthly mortgage payments gets you closer to owning your property debt-free. Owning a house makes it easier to build wealth, and a fixed-rate mortgage ensures your monthly payments stay the same, unlike rent. On the other hand, an adjustable-rate mortgage will have varying payments, but you can benefit from an interest rate cut.
While some people make mortgage payments to become debt-free as soon as possible, others may want to refinance their mortgages. A refinance can lead to several outcomes, all of which can strengthen your finances. However, a refinance doesn’t make sense for everyone. This guide will explore some of the factors to consider before getting a refinance.
Jump To
How does a mortgage refinance work?
A mortgage refinance involves swapping your original mortgage for a new one. You’ll definitely end up with a new interest rate, and you may also end up with a new term. Some people replace an old 15-year mortgage with a new 15-year mortgage. Other homeowners may add or subtract a few years during a refinance.
When you get approved for a refinance, the capital from your new mortgage goes toward your existing mortgage. You won’t get stuck with paying two monthly mortgages.
You will have to get a home appraisal before getting a mortgage refinance. Lenders will use the home’s value to determine how much equity you can invest. You will also have to apply for several refinances and choose from the lenders that accept your application.
Many mortgages have prepayment penalties, so you may have to pay those extra costs for your current mortgage. However, you will also have to pay closing costs for your new mortgage, ranging from 2% to 6% of the new mortgage’s balance. You can pay closing costs immediately or tack them onto the back of your loan. You can use the mortgage refinance calculator below to consider whether it makes sense to opt for it.
Mortgage Payoff Calculator
The types of mortgage refinances
You can work with many mortgage lenders who offer refinances. However, the available financial products remain the same, regardless of the lender. These are the refinance options you can consider.
Rate and term refinance
A rate and term refinance allows you to change the rate and term of your mortgage. However, everything else remains the same. Some mortgages only involve changing the rate while keeping the new loan’s duration the same. However, you can add a few extra years to your home loan to minimize your monthly payments.
Homeowners who want to get out of debt sooner can shorten their new mortgages instead of extending them. These individuals can turn a 15-year mortgage into a 10-year mortgage. This approach increases your monthly payments, but you will get out of debt sooner if you stay on schedule. It’s best not to get too aggressive with this model so you avoid getting an additional refinance to make the monthly payments more manageable.
Cash-out refinance
A cash-out refinance allows you to tap into the equity you have built into your current home. You build home equity with each monthly mortgage payment and as your property appreciates. Homeowners will have higher mortgage balances but can extend their mortgage terms to keep their monthly payments the same.
If you have a $300,000 mortgage balance and want to tap into $200,000 worth of equity, you must refinance into a $500,000 mortgage. Changing the loan term from 15 years to a new 30-year loan can keep the monthly payments at a similar level, but you will stay in debt longer and owe additional interest.
Your loan-to-value ratio will become important if you opt for a cash-out refinance. Most lenders will not let you have an LTV ratio that exceeds 80%. For instance, if you have a $1 million property, your combined mortgage balances and HELOCs cannot exceed $800,000. Some lenders allow for LTV ratios as high as 95%, which lets you tap into more home equity.
Cash-in refinance
A cash-in refinance allows you to contribute some cash toward the mortgage balance. This strategy requires that you have available funds, which can get you out of debt sooner. A cash-in refinance can be a good option if you recently received a financial windfall. You can put those funds into a refinanced mortgage with a lower balance.
For instance, if you have a $500,000 mortgage balance and receive a $300,000 inheritance, you can refinance to a $200,000 mortgage and use the inheritance to cover the rest. Depending on the financial windfall, you will then have lower monthly payments, a shorter loan term, or even both.
Pros and cons
Pros
- Potentially lower your monthly payments
- You can end up with a lower interest rate
- Tap into the equity you have built in your home
Cons
- Prepayment penalties and closing costs can apply
- You may stay in debt longer and pay more interest in the long run
- Using a refinance to get out of debt sooner will result in higher monthly payments
American Homeowners Could Save Big With The Help Of U.S. Mortgage Experts
If you've owned your home for 3+ years, you may be able to get cash out of your home and slash your monthly bills. It costs $0 to get connected with an expert and check your options. You'll be shocked to see how much you could save.
Who should get a mortgage refinance?
Homeowners who need extra cash for a big expense
A refinance isn’t the best choice if you only need a few hundred dollars. However, a mortgage refinance can give you the extra capital you need if you have medical bills, a big vacation, or college tuition payments due soon.
People who want to lower their monthly payments
Mortgage refinances can make a lot of sense when mortgage interest rates fall. Getting a lower rate on your loan can reduce your monthly payments, but you don’t have to wait for rates to drop to get some financial relief. Mortgage refinancing and adding more years to the backend can reduce your monthly payments, even if you have a higher interest rate.
Individuals who need help with other debt
Refi can get expensive, and you can wind up with additional interest payments. However, the interest rate you receive for a mortgage is much lower than other loan types. Unsecured debts like personal loans and credit cards carry higher APRs. Most credit cards have APRs that can get as high as 29.99%.
A home loan refinance can wipe out your credit card debt and give you a fresh start. You can catch up on late payments and begin the credit repair journey. A refinance can also make debt repayment more manageable since you can increase the amount of time to reduce your monthly payments.
Who shouldn’t get a mortgage refinance?
People who want to get out of debt sooner
Except for cash-in refinances and securing a lower interest rate, most refinances do not get you out of debt sooner. Prepayment penalties and closing costs will increase your total mortgage balance. If you stretch out your loan, you will also pay more interest over the loan’s duration.
Homeowners who are close to the finish line
Most mortgage refinances make less sense as you get closer to paying off your mortgage. While a cash-out refinance still has its uses, a rate and term refinance doesn’t make as much sense when you have less than five years left.
If you are that close to the finish line, you may want to consider making an additional monthly payment toward your mortgage loan. These additional payments get by the amortization schedule and allow you to make a more meaningful dent toward your principal payments.
Individuals who have bad credit
Mortgage lenders will look at your FICO score, debt-to-income ratio, and other factors before assessing if you qualify for a mortgage refinance. The minimum credit score for conventional refinances is usually 620, but some lenders may have higher standards.
Some government-backed mortgages, like FHA loans, have lower credit score requirements. However, getting a refinance with a low credit score is still not a good idea, even if you get approved. That’s because lenders set higher interest rates for borrowers who don’t have the best credit. A higher interest rate can increase your total expenses by thousands of dollars over the life of the loan.
Some homeowners may benefit from raising their credit scores before applying for a mortgage refinance. However, if your financial situation doesn’t offer any flexibility to build credit leading up to a refinance, you should compare offers from multiple lenders.
American Homeowners Could Save Big With The Help Of U.S. Mortgage Experts
If you've owned your home for 3+ years, you may be able to get cash out of your home and slash your monthly bills. It costs $0 to get connected with an expert and check your options. You'll be shocked to see how much you could save.
Alternatives to a mortgage refinance
A mortgage refinance offers versatility, but these aren’t the only products you can use to access extra cash and tap into your home equity. These are some of the alternatives to consider.
Home equity loan
Home equity loans allow you to borrow capital against your home equity position. However, it essentially turns into a second mortgage. You must make fixed monthly payments for your current mortgage and the home equity loan.
While you get stuck with an additional monthly payment, you also get to preserve your current mortgage. Homeowners who got low mortgage rates before the pandemic want to keep them. A home equity loan gives you extra financing while letting you keep favorable terms for your current debt. Home equity loan terms usually have fixed interest rates and range from 5-30 years.
Home equity line of credit (HELOC)
A HELOC offers the same premise as a home equity loan. Both financial products use your property as collateral, tap into its equity, and let you keep the current rate and term on your mortgage.
However, a HELOC has an initial draw period lasting up to 10 years. You will have lower monthly payments during this draw period than a home equity loan. You also don’t pay interest on a HELOC until you borrow against the line of credit. You can open a HELOC and not pay interest for several months if you don’t borrow against the credit line. On the other hand, interest accrues right away for a home equity loan.
Once the draw period concludes, the remaining balance is converted into an installment loan with a term of up to 20 years.
Personal loan
These unsecured loans have higher APRs than home equity loans and HELOCs, but obtaining these financial products doesn’t take as much effort. You don’t have to do a home appraisal; some lenders have relatively low credit score requirements for their personal loans. You also won’t have to use any collateral for this loan.
Credit cards
Credit cards allow you to cover various expenses and receive rewards as you continue to spend. Many cards offer unlimited cash rewards ranging from 1% to 2%, and some have elevated rewards for certain categories.
Credit cards are the best choice for expenses you can pay back before the end of the month. If you pay your balance in full each month, you get all the perks of having a credit card without any downsides.
However, the downsides are significant if you let your balance linger. Credit cards can have APRs as high as 29.99%, keeping you in debt longer. A mortgage refinance can be more affordable, and you can even use those proceeds to pay off your credit card debt.
Making an additional payment each month
People who want to get out of debt sooner with a refinance may want to make an additional monthly payment instead. Making bonus payments toward your mortgage ensures that more money goes toward the principal. Amortization schedules prioritize interest payments first, so your additional contributions get your principal payments to the front of the line.
Shaving off several years from your mortgage is possible with a few additional payments spread throughout the year. You can use a financial windfall to trim your current mortgage balance instead of getting a new home loan and going through that process. The money that would have gone toward closing costs can go toward paying off your balance instead.
American Homeowners Could Save Big With The Help Of U.S. Mortgage Experts
If you've owned your home for 3+ years, you may be able to get cash out of your home and slash your monthly bills. It costs $0 to get connected with an expert and check your options. You'll be shocked to see how much you could save.
The bottom line
A mortgage refinance offers plenty of flexibility. You can use a refinance to minimize your monthly payments, tap into equity, reduce your interest rate, or get out of debt sooner. Some home loan refinances accomplish multiple objectives simultaneously.
However, a refinance isn’t right for everyone. Choosing the best mortgage isn’t easy either. It’s important to assess your financial situation and long-term financial goals before reaching out to lenders. Reviewing your personal finances and comparing offers can lead to a better decision.
Joy Wallet is an independent publisher and comparison service, not an investment advisor, financial advisor, loan broker, insurance producer, or insurance broker. Its articles, interactive tools and other content are provided to you for free, as self-help tools and for informational purposes only. They are not intended to provide investment advice. Joy Wallet does not and cannot guarantee the accuracy or applicability of any information in regard to your individual circumstances. We encourage you to seek personalized advice from qualified professionals regarding specific investment issues. Featured estimates are based on past market performance, and past performance is not a guarantee of future performance.
Our site doesn’t feature every company or financial product available on the market. We are compensated by our partners, which may influence which products we review and write about (and where those products appear on our site), but it in no way affects our recommendations or advice. Our editorials are grounded on independent research. Our partners cannot pay us to guarantee favorable reviews of their products or services.
We value your privacy. We work with trusted partners to provide relevant advertising based on information about your use of Joy Wallet’s and third-party websites and applications. This includes, but is not limited to, sharing information about your web browsing activities with Meta (Facebook) and Google. All of the web browsing information that is shared is anonymized. To learn more, click on our Privacy Policy link.
Images appearing across JoyWallet are courtesy of shutterstock.com.
Writer
Marc Guberti is a business freelance writer who specializes in personal finance, digital marketing, and entrepreneurship. His award-winning book "Content Marketing Secrets" teaches readers how to create, promote and optimize content for growth and revenue. Marc also hosts the "Breakthrough Success Podcast," where listeners learn how to master content marketing and get more clients.
Share this article
