The best way to refinance a mortgage: Follow these 6 tips

Pete Gerardo
The Mortgage Reports contributor

Reduce your mortgage refinance costs

The mortgage refinance process can be intimidating.

The goal is to trade in your current mortgage for a new one that reduces your rate and builds equity faster.

But making mistakes during the process can increase your costs and undermine your goal.

The best way to refinance is to know the most common mistakes and how to avoid them. Here’s what to do.

Verify your refinance eligibility (Dec 4th, 2021)

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6 Tips to get the best mortgage refinance

A big part of refinancing is finding the lowest interest rate. This will maximize your savings and make your refinance all the more worth it.

But that’s just one part of the equation. There are multiple strategies you can use to get the most out of a refinance. Here are the best practices you should be following.

1. Optimize your credit score

Your credit history is one of the most important criteria lenders look at when you start the mortgage refinancing process. 

A one-point credit score increase — from 679 to 680 — could reduce your mortgage fees by one point. That’s $1,000 for each $100,000 borrowed.

Purging errors with a rapid rescore could also raise your credit score by as much as 100 points in less than a week.

In a recent survey of nearly 6,000 consumers, more than a third of survey participants found errors in their credit reports. And almost 12% of the survey’s participants found errors that would affect the interest rates they get on loans.

Higher interest rates increase the monthly payments and long-term cost on your new home loan. So it’s in your best interest to find these credit errors and correct them ahead of time.

Before you start a refinance, order your credit reports from Equifax, TransUnion, and Experian. Federal law allows consumers one free credit report each year from each bureau. During the pandemic, you can get a free report each week.

Immediately report any errors you find. The bureau must remove any credit line it can’t prove is yours.

2. Comparison shop for the best mortgage refinance rates

A Consumer Financial Protection Bureau (CFPB) survey discovered that nearly half of all homeowners requested a mortgage quote from just one lender.

Consumers who received rate quotes from multiple mortgage lenders cut their interest rate by as much as 50 basis points (0.50%).

That’s more than $14,000 in mortgage interest savings on a $300,000 loan over 10 years.

Your current lender or local bank may not offer your best refinance option. Compare rates and fees from three to five mortgage lenders before you decide on one.

Compare refinance rates. Start here (Dec 4th, 2021)

3. Tap home equity carefully

About one-in-four homeowners are “equity-rich,” according to a recent study

That means they have at least 50% equity in their home — money that can be tapped with a cash-out refinance to accomplish other financial goals.

But one common mistake is using that equity to finance short-term expenses.

For instance, a car with a five-year life may not justify a 30-year mortgage loan. You’d still be paying off that car more than 20 years after you stopped owning it.

Likewise, a mortgage is an expensive way to pay for a month-long cruise. And while using equity to pay off high-interest credit card debt can create monthly savings, you could still be paying off that debt for decades.

Homeowners may receive more value by investing their equity in home improvements, a college education, or a promising business venture with proceeds from a cash-out refinance.

Will your equity, if tapped, yield long-term returns? If the answer is “yes,” then a cash-out refinance might be your next step.

Or, if you’re looking for a shorter-term way to borrow against your equity, consider getting a home equity loan or home equity line of credit (HELOC) instead of a cash-out refi.

4. Make sure your refinance is worth it

Mortgage interest rates are far below their historic norm. 

Homeowners who purchased a home as little as one year ago likely stand to save by refinancing at today’s rates. 

But a refi isn’t always the right decision. 

Here’s why: Frequent refinancing extends the mortgage term again and again.

Remember, a refinance after five or 10 years “resets” the loan, often to 30 years. The rate and monthly payment may fall dramatically, but you could still pay more over the life of the loan.

Plus, you’ll likely have to pay closing costs with each new loan unless you find a no-closing cost loan program.

Sometimes the lowest possible payment is priority one for a homeowner with limited cash flow. Perhaps a divorce, layoff, or illness reduced income. In these cases, extending the loan term could be a wise move, even if it does cost more in the long run.

But financially stable borrowers should focus on lifetime savings instead of lower monthly payments. 

One strategy many homeowners employ is to refinance into a mortgage with a shorter term. That’s why 15-year refinances are growing in popularity

Or, you could simply make additional principal payments to avoid extending your repayment time frame. With this strategy, you don’t have to commit to the higher mortgage payments a 15-year loan would require.

5. Know your property value

Home values rose steeply during the pandemic. The median price of a home in June of 2021 was just over $363,000 — up from about $294,000 a year earlier, according to the National Association of Realtors.

This rise in the median price of a home may have increased your equity, but you’ll need to find out for sure before beginning your refinance process.  

Without an accurate estimate of your home’s value, you could easily pay too much to refinance the mortgage.

If your estimate is too low, you can overlook savings opportunities. Adequate equity lets you eliminate private mortgage insurance or obtain a lower interest rate.

Conversely, if your estimate is too high, you may not get your desired mortgage rate. Less equity increases your loan-to-value ratio and can mean higher rates.

That being said, some loan products do not take your home’s value into consideration. 

The FHA Streamline Refinance does not require an appraisal, and it is available to current FHA homeowners. You can’t get cash out, but you can replace your original mortgage with a lower-rate loan, creating monthly savings.

Likewise, the VA Streamline Refinance or ‘VA IRRRL’ does not require a new appraisal and therefore doesn’t take your home equity into account when determining your eligibility for a refinance.

However, if your loan type requires documented home value, there are several ways to obtain a realistic estimate so you’ll know the value of your home going into the refinancing process.

Online valuation tools have improved. Even better, you can request a Broker’s Price Opinion (BPO) or Comparative Market Analysis (CMA) from a local real estate agent. The cost, if any, is a fraction of a typical appraisal fee.

6. Negotiate rates and fees with refinance lenders

You don’t have to accept a refinance offer “as is.”

In addition to interest rates, many fees may be negotiable. Multiple offers may persuade lenders to compete against each other for your business.

Third-party fees like title, escrow, and origination fees may be negotiable, depending on your state’s laws.

Provided you have good credit and do a little comparison shopping, you should have enough leverage to bargain for a better deal.

Compare refinance offers. Start here (Dec 4th, 2021)

The best way to refinance a mortgage

A refinance simply means you trade your current loan for a new loan that is better in some way.

Some homeowners refinance to lower their monthly mortgage payment or interest rate. Some refinance to turn pent-up home equity into needed cash. Some want out of an FHA loan so they can stop paying mortgage insurance premiums.

Still others refinance into a shorter term, like a 30-year loan into a 15-year one. And many homebuyers who got an adjustable-rate mortgage want to refinance into a fixed-rate mortgage.

Whatever your reason, any refinance is completed with essentially the same process:

  1. Make sure the refinance benefits you. Know your ultimate goal and see if you can achieve it. If you need a lower rate, make sure current rates are low enough. If you need cash out, make sure you have enough equity
  2. Contact a lender. Yes, this can seem scary. But, by law, there is never any obligation to proceed with a refinance. You can cancel the whole thing up to the day before closing! But a lender, in minutes, can give you an accurate rate quote, check your credit, and send you numbers in writing
  3. Shop for rates. You could reduce your rate by as much as 0.50% by contacting a few different lenders and discussing different loan options
  4. Make full application with your chosen lender, which includes providing supporting documents
  5. Sign initial disclosures that the lender will send you. Verify loan terms on the disclosures. Make sure you are still accomplishing your goal (lower rate, cash out, shorter term, etc.)
  6. Submit loan conditions. The lender will submit your paperwork to the underwriter, who will request additional needed items, if any
  7. Sign final paperwork which the lender prepares. Your closing will be facilitated by an escrow company
  8. Wait three days. This is the rescission period — a “cooling off” stage in which you have the chance to cancel the refinance at no cost. (Remember: your current loan is still intact, and no changes have been made to it. Simply continue making payments)
  9. Check with the lender on the fourth day. The loan will “fund,” meaning it’s a done deal. Your previous loan has been paid off in full
  10. Start making monthly payments on the new loan. The first payment will be due 30 to 60 days after funding

Follow these steps, and you should be able to meet your refinance goals — whether you want to save money with a low rate, pay off your mortgage balance faster, or cash out your home equity. 

Mortgage refinancing FAQ

Is there a catch when refinancing your mortgage?

In a way, yes. The catch is that refinancing costs money. You’ll pay upfront closing costs for most refinance loans. To make your new loan worthwhile, you’ll need to save more money with the new loan than you’re spending at the closing table. Or, you’ll need to accomplish another goal such as lowering your monthly payments to help with cash flow.

How long does it take to recover the costs of refinancing?

You could recover the costs of refinancing within a year, but it usually takes a few years. The answer depends on the specifics of your situation. If you’re shaving 2 to 3 percentage points off your interest rate and have low upfront closing costs, you’ll likely recover your refinancing costs quickly. But it could take years to reach your break-even point if you’re getting only a slight interest rate reduction and/or your closing costs are high.

When should you not refinance?

Refinancing won’t make financial sense if the upfront costs exceed the amount of money you’ll save by refinancing. It also typically doesn’t make sense to refinance if you’ll end up spending more on mortgage interest in the long run due to an extended loan term. This might be true if you’re already 10 years or more into a 30-year loan, or if you plan to sell the home within a couple years.

Do you lose equity when you refinance?

Yes, you can lose equity when you refinance if you use part of your loan amount to pay closing costs. But you’ll regain the equity as you repay the loan amount and as the value of your home increases.

Can you get denied for a refinance?

Yes. In most cases, refinance lenders check your credit score and debt-to-income ratio just like your existing mortgage lender did. You could be denied a loan during the underwriting process if you don’t meet the lender’s minimum requirements. Streamline refinances offered by VA, FHA, and USDA are usually easier to get as they don’t require credit or income verification (though some lenders take those steps anyway).

How often can I refinance?

Unless your lender or loan program requires a waiting period, you can refinance anytime. But should you? Refinancing works best when your new mortgage accomplishes a goal such as shortening your loan term, lowering your monthly payment, tapping equity, or getting into a lower rate. Refinancing repeatedly could see you spending more in lender fees than you’ll save or extending your loan term to the point where you pay more interest in the long run. So before you refinance, run the numbers and make sure the new loan has an overall financial benefit.

What are today’s mortgage rates?

Mortgage rates are low and continue to sit below historical levels. Today’s rates combined with refinance best practices yield solid value for homeowners.

Request a refinance rate today to see how much you could save.

Verify your new rate (Dec 4th, 2021)